Aston Goodey looks at the options available to people looking to phase into retirement
For many people the days of reaching state pension age, taking possession of the carriage clock and kicking back into retirement are gone. Working beyond retirement age is becoming increasingly common, and will continue to increase as the baby boomer generation moves into the so-called 'third life' stage.
However, what is driving this need? According to the Retirement Nation study conducted by MGM Advantage, 17% of retirees have headed back to the world of work, and a fifth of those have done so through financial necessity. Increasingly though, this is a lifestyle choice as people reach retirement and don't feel ready to give up the benefits that working can bring. After all, with people living well into their eighties and nineties, they feel fit and able to work longer and actually feel the need to keep active.
Of course the very nature of living longer also means that they may have many more years in retirement to finance than the preceding generation, but they are also intent on making a lot more of this stage of their life. There are things to do, places to see, activities to finance. Life in retirement is both longer and more expensive, and something has to finance that.
Changing customer needs demand different solutions
So, what do these changing needs mean for people's pension income? The 'reinvention' of retirement brings with it a change in the financial needs of the customer. Arguably, there may come a time when moving a pension fund straight into a level conventional annuity at state retirement age is as out-dated as staying with your own bank for a mortgage because that was your only option.
For many customers, taking a phased approach to retirement is already a reality, and locking into a level conventional annuity at outset is far too inflexible and unlikely to meet their longer term needs. In particular this is the case for the healthy mass affluent customer who does not qualify for an enhanced annuity, and is likely to be caught out by postcode and lifestyle priced annuities.
For some, income drawdown has stepped in and gone some way to addressing their needs - particularly since A-Day made it more attractive to the mass market. The increasing popularity of income drawdown is largely symptomatic of the need to remain as flexible as possible. Many customers going into drawdown do so in order to release tax free cash, but retain the death benefits of their pension fund. They don't necessarily need an income as they may still be in part or full time work, or be drawing an income from other sources such as investments or an inheritance.
Income drawdown offers a phased approach to retirement income and means that customers can wait longer before annuitising. The theory is that the longer they wait, the more likely they are to qualify for an enhanced rate for medical reasons, and they will also benefit from a higher income rate because they are older.
Risk versus reward
However, recent financial conditions have highlighted some problems with this approach. The need for flexibility for a phased and changing retirement is one thing, but the need for guarantees is equally strong. After all, the customer may have another 25 or 30 years in retirement, and the possibility of completely eroding their retirement earning potential with no income guarantee is not for the faint hearted.
While income drawdown delivers the required flexibility, traditionally it offers no guarantees, and really only serves to extend the growth potential of the pension fund while giving the customer access to tax free cash. Indeed, flexibility and guarantees are not generally wedded in the world of retirement income, and any attempt to do so have, to date, been refuted by the industry as too complex and too expensive.
The other problem with delaying annuitisation in favour of drawdown is that in general, level conventional annuity rates are on the slide, which may negate the potential increase in annuity rate through qualifying for an enhanced annuity. This is not just due to the performance of the underlying assets, but also a longer term view of increased longevity. Annuity providers are recognising that they are going to have to pay people less for longer.
The holy grail
It feels like something has to give. The question is - is there a happy medium where ...
- the customer takes a little bit of added risk in order to position themselves for a better longer term income
- their income level is flexible so they can change it as their lifestyle changes
- their income is guaranteed so that no matter what, they will not be penniless
- they can choose how much investment risk they want to take, and can change this as their risk appetite changes
- they don't have to pay the earth
- it doesn't take a rocket scientist to make sense of it.
Arguably yes, but these options are fraught with issues. Further research conducted by MGM Advantage shows that the with-profits annuity, perhaps somewhat unfairly, suffers from a perception of a lack of transparency, complexity and poor performance. The unit linked annuity is deemed too complex and there is a lack of uniformity to allow advisers to make sense of this market.
What is evident is that there is a very real and unmet need for customers. Phasing into retirement will soon become the norm and even if it doesn't, the need for income flexibility and an income that grows will. This need demands a new category of annuity - a new generation conventional annuity, which doesn't lock customers into gilts and fixed rate assets while allowing for flexibility and room for growth. It's not a question of 'if' this will become the retirement income norm, merely a question of when.
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