The compulsion to purchase an annuity by age 75 has been enshrined in legislation for many years. Bu...
The compulsion to purchase an annuity by age 75 has been enshrined in legislation for many years. But as a result of low interest rates and improving life expectancy, a bandwagon is rolling to remove the compulsion for annuity purchase.
Bear in mind that over many years, the Pension Scheme Office (PSO) has always seen a pension scheme as a means of securing retirement benefits. Our industry has seen pensions as tax-planning tools, providers of bank loans, property investment vehicle ' basically anything but a means of securing retirement benefit.
Before we go further into this debate, we should consider the alternative to annuity purchase ' income fund withdrawal. This is only realistic for clients who can afford to take a considerable risk. Remember, the interaction of risk between yield, annuity rate and mortality drag is complex and not easily understood, even by the most experienced investor. After one bad year, we are now in the second year where critical yield may not be achieved, and income will fall.
This leads to the question of how removal of compulsion to purchase an annuity can make sense for small funds when the vehicle that would replace the annuity carries a risk profile too high for most clients. If annuity compulsion were removed, a critical yield calculation will almost certainly be required and the result will be too high for most clients' risk tolerance.
There is, however, one area where the 75 rule is a real problem and that is how it relates to income fund withdrawal. The compulsion to annuitise means a fund must be in cash by age 75. This means liquidation must start earlier, placing more strain on the non-cash portion to attain critical yield. Combined with the need to pay income, this factor makes income fund withdrawal an unrealistic proposition for people in their 70s. Everyone sees the issue as one of poor value annuities, which has been fuelled by inaccurate reporting in the national press.
According to many analysts, annuities are now more competitively priced and in the consumers favour than at any time in the past. Low interest rates and low inflation give a real interest rate return of more than 3% a year. This leads to the issue of whether historically high interest rates and high inflation have led to inadequate funding provision. If you note projections of 13% a year, I suspect the answer is yes.
There is a further problem, namely the issue of public perception. The majority of males still believe they will die at the biblical three score years and 10, whereas the reality is that they are likely to live until their mid-80s. This means that when considering annuity value, they multiply the income by five rather than in excess of 20. Life expectancy is improving at between 2-3% a year, and so the lifetime guarantee is valuable.
So what can be done about annuities? I believe the real villain is the outdated rules that surround annuity design. For example, a five-year guarantee can be commuted, but a 10-year one cannot. Why? The only answer can be that rules were made based upon age 70 as male life expectancy. There is an urgent need for these rules to be revisited to enable annuity design to be brought into the 21st century.
One final thought ' a 60-year-old still has one third of his life before him. This fact alone must mean that a rethink is long overdue.
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