A ticking time bomb

A ticking time bomb

Fri 04 Jul 2014

The future of annuities and how to get the most out of your retirement

Brian Please, Business Development Director for Equiniti Paymaster, discusses the future of annuities and what can be done to ensure people get the most out of their retirement.

It was announced in the recent Budget that from 2015 people will have the freedom to do what they want with their defined contribution pensions and will not be required to buy an annuity. The Chancellor was absolutely right in terms of the importance and potential for individuals to get more out of their pension savings. I only worry that the headline-grabbing message of damning annuities, whilst having the impact he was after, undermines the unique value annuities will always have in the right situations.

The current generation approaching retirement age is in a transitional phase. People will receive their state pension much later on in life as the state retirement age rises. They will have a reasonable amount from final-salary pensions, but the majority of those pension schemes are now closed and their defined contribution pensions will not be enough to make up the shortfall. People were expected to retire for only 5-10 years a generation ago, but as life expectancy increases, this has now risen to 30 years.

The outlook for future generations is bleaker. They will have no final-salary pensions, the current level of state pension cannot be relied upon, and unless they save materially through auto-enrolment and other savings, they will not have enough money to retire. The bomb is ticking, and as time goes on, the problems will become more compounded with each generation.

Annuities have their challenges: what you can buy with an annuity today is much less than before, and each group of people will find it harder to generate enough income to support their whole retirement. Buying an annuity is a one-off, irreversible decision, but there are a few small, simple steps those approaching retirement can take to help.

A most fundamental question relative to this needs to be asked: when should I and can I afford to retire? It is assumed that people will buy an annuity when they reach the age of 60 or 65, but what if they decide to work for longer? People are being compelled to buy an annuity whether they are ready or not. Every year they defer their retirement, the better the annuity rates are that they are entitled to.

The bomb is ticking, and as time goes on, the problems will become more compounded with each generation.

Having planned for retirement, people need to shop around to get the best-value annuity; it’s an open market and people are not necessarily offered the best rates from their own pension providers.

It’s also important to actively seek out information and advice. The Association of British Insurers states that six months before a person is due to retire, a wake-up pack should be sent out. This is far too late, and the process needs to begin at least five years before retirement so people are planning for their futures.

People usually purchase a standard, single-life annuity but those products don’t take inflation into account, don’t include death benefits and ignore their spouse. People should also consider enhanced annuities over a standard annuity where they may be entitled. If someone has a medical condition, for example, which means their life expectancy is lower than average, then they can get a significantly higher income from their annuity. 

The issue with annuities is that they are rigid products, which becomes difficult later in life if a person becomes ill and needs long-term care. You find people selling their houses or at least releasing equity in their property, which may have been their children’s inheritance, to fund their long-term care. It’s a huge social challenge, and annuities may need to become more flexible to help people adapt and cope in that scenario. 

For future generations, I think financial education will be key. They need to see the value of saving and investing, whether this is for a pension, an ISA or property, and their expectations about when they can retire and the lifestyle they can afford will also need to be managed.

Yet, despite these issues, annuities are good products. There is no other product that delivers a guaranteed income for life. If annuities become more flexible and people become more aware of the type of annuity they could buy and invest more time in researching the best rates, there are products that are fit for purpose for the foreseeable future.

Pensions are all change

Pádraig Floyd looks at the recent pension changes

Although there is one more Budget to come before the next general election, it is unlikely to be as radical as this year’s Budget. Osborne promised to remove all restrictions on how pension funds are taken at retirement, and the reforms proposed by the Chancellor will have a considerable impact on the pensions industry.

Even though the minimum age at which a defined contribution (DC) scheme member can take their pension will rise from 55 to 57 in 2028, those with DC schemes will have greater access to their pensions. They will be able to take their pension fund as a lump sum, drawdown or annuity, and the pension commencement lump sum or tax-free cash will still be available up to 25%. 

As the Budget allows the total fund to be taken as cash, the rate of taxation will be at the member’s marginal rate rather than the punitive 55% rate it is currently set at. 

Other changes include the lowering of the guaranteed income requirement for flexible drawdown to £12,000, from £20,000. Capped drawdown limits will also increase from 120% to 150% of Government Actuary Department’s (GAD)  rates. Those with single small pension pots will now be able to take up to three as cash lump sums (previously two) from the age of 60 up to the value of £10,000 each (previously £2,000). Trivial commutation limits also increase to £30,000 from £18,000.

Andy Robins, Head of Implementation at Equiniti, says: “Access to small pots will increase the demands of scheme administration and may introduce some degree of risk. Knowing your scheme’s regulatory requirements and having a robust communication structure in place for every stage will be essential to maintain both good relations with members seeking transfers and high levels of governance.”


Image from Getty Images.