Annuitisation – friend or foe?

In the first of our new series of comment pieces, Helen Morrissey and David Stevenson give their views on annuitisation.

The case against..... by David Stevenson, freelance journalist

Tim Bond is a fairly balanced chap. BarCap’s head of asset allocation is paid to take a considered view of most things, balancing out the competing forces at work in the global economy, teasing out how they will impact actual investment policy. But every once in a while he will let slip what really animates him and retirement annuities is clearly one of those ‘hot button’ topic’s. Chatting to him about the prospects for growth in the UK and the difficulties of building a sensibly diversified portfolio, Tim suddenly lunged into an attack on the mandatory rules that force the vast majority of pensioners to buy an annuity: “It is so scandalous that you still have to convert to fixed income. I mean that really is a scandal and it should be abolished because it is utterly random how [the effect of yield levels on gilts will] fall on you. I think it is terrible, it is a disgrace…. it has got to be left either to the individual or to the manager...to make the decision.”

And he is right of course. Despite the odd half hearted industry lobbying campaign this truly dreadful rule remains in place and is causing untold misery to millions of people who have worked bloody hard only to see their income fall off the edge of a cliff. And let us call a spade a spade here – it is absolutely right that the government is prompting a debate on longevity after 65 and its implication on financial planning, state pensions and healthcare. But that same demographically inspired policy shift also explains why the current regime on annuities is becoming completely untenable – I would call it financially ruinous, of epic proportions.

There are two other reasons why we need to do something now. The first is that I believe this daft rule is beginning to have an effect on some investor’s perceptions of investment. I know of many fairly world wise investors who are refusing to save much money into their pension plans because they do not want to a) be forced to starve in their old age as annuity rates continue to fall and b) give away all that hard earnt money to life assurers when they die two years after taking out the annuity.

The other big reason for immediate action is that I think we are only mid way through a continued period of heightened volatility with real concerns about the viability of economic growth prospects in the developed world. Markets both in equities and bonds will continue to be very fragile, populated by pronounced bull pushes followed in turn by debilitating bearish periods where the markets drift. That makes life nightmarish for pensioners planning to buy those annuities – if they are lucky they will hit a period of elevated bond yields, if they are unlucky they will hit close to zero rates as governments try and engender a recovery. Buying an annuity has quite literally become a bit like playing the roulette wheel.

Now I realise that advisers will be quick to suggest clever wheezes like new style annuities that preserve capital as well as ASPs and other even more fiendishly complex acronym based schemes but it is all just a diversion for wealthy clients who can afford to come up with the clever tricks. People like my step father cannot afford that advice and are, to use his favourite word on the matter, kippered – in his mid seventies he is now forced to take up some small jobs to make ends meet. And this horrible truth is dawning on millions across the land – pensions are nowhere near enough, especially when annuities are factored into the equation.

The problem is that we all just sit idly by and accept the bullshit trotted out by the Treasury – Fabian influenced nanny state nonsense designed to protect us against our own worst behavioural excesses (good god, these private investor types might even invest the cash in some dodgy equity income fund to boost their income, Minister). But behavioural economics suggests that a better way of regulating investors chasing excess yield is to build incentives into a system that discourages the embrace of too much risk. 

Failure to change the current regime will, I predict, cause untold damage to the pensions based savings industry in the UK. Younger investors who cotton on to this will begin to sideline pensions and use other tax vehicles ( I mainly use an ISA for my long term planning), carry on treating their home as a pension (foolishly) or just not save at all! The rule has to go and it has to go now. And I would suggest that the time has come for us all to get our collective ‘act’ together and do something – we will be facing a new government imminently and there is a fair chance that some root and branch review of the incentives to invest and save will be required of the new government. Let us barrage the Tory and Lib Dem finance spokesmen with suggestions for a new income based retirement system that does not use these toxic annuities. Let us get the emails humming and get to work!

The case for..... by Helen Morrissey, editor of Retirement Planner

I have been writing on pensions and retirement for six years now and have always been impressed by the passion and vigour of pensions professionals when they are discussing topical issues around savings rates, retirement income options and investment strategies. 

People hold strong views about these topics, and rightly so, as increasing longevity means the average UK pensioner can look forward to a long retirement and they need to ensure they have adequate means to meet their needs.

However, the one topic that provokes the strongest response is that of annuitisation. People either love annuities or they hate them – I for one am a fan! There does not tend to be much room in-between. All you have to do is read Mr Stevenson’s piece to see that. However, are such one sided views helpful – I think not.

When talking about effective compulsory annuitisation at age 75, Stevenson refers to it as a “truly dreadful rule” causing potential “untold damage” He refers to annuities as “toxic” and the process of purchasing one “has quite literally become a bit like playing a roulette wheel”. 

According to Stevenson, many worldly wise investors are not saving into a pension because they “don’t want to be forced to starve in their old age as annuity rates continue to fall” yet on the other hand they also “don’t want to give away all that hard earnt money to life assurers when they die two years after taking out the annuity”.

Reading such views it would seem that the future is indeed bleak for annuities. They obviously are not fulfilling people’s needs – and being effectively forced to purchase one is to pour your money down the drain. Is this true? 

Not at all. The fact remains that the humble annuity has, and will continue to form the backbone of UK retirement income provision. Increasing longevity means that people are getting more from their annuities and sustained innovation means there are many different types of annuity to meet people’s needs.

If people want an annuity tailored to their health conditions you can get one, if they want it linked to inflation they can have that too. If they want exposure to investment markets they can also have that.

However, let us be clear what the annuity offers above and beyond anything else is certainty. Certainty is not a dirty word – it is a good thing – it means something to people. Even the most hardened investor will come to a point in their lives when they do not want to be checking the performance of their portfolios every day as they would prefer to be enjoying their money instead.

If purchasing an annuity is like gambling on a roulette wheel then what of the alternatives? What has happened to those retirees fully invested in drawdown over the past few years? Surely they are the ones who have really seen their retirement income fall off a cliff. 

I agree with Mr Stevenson in that the retirement market does need to see innovation if it is to continue to move with the times. However, it is unfair to blame annuities for the problems this market faces. People are living longer but then annuities do pay out for the duration of the annuitant’s life. While people may find their retirement income is not what they expected, this is often because they did not save enough to begin with. We do need further flexibility but then we have seen real innovation from annuities in recent years.

It is true that many people are looking to alternative savings vehicles like ISAs as they do not like the fact they cannot access the money in their pension until retirement. I am also a fan of the ISA – I save into one too, but guess what I do with that lovely easily accessible money – that’s right I spend it. I spend it on holidays, I spend it on Christmas presents for my family, I spend it on shoes! I for one like the fact that I cannot access my pension money – the pension is preventing me from becoming a penniless pensioner in the future.

The retirement market certainly faces its challenges. It would be good to introduce more flexibility and as we live longer the age 75 rule does need to be looked at. However, it is important to note that there is room for different products in a retirement planning strategy. 

We are increasingly seeing advisers use elements of both drawdown and annuities for their clients. They recognise that while the investment upside of income drawdown is good, the certainty of annuities is also vital. So, I think it is time we stopped blaming the annuity for our retirement woes and see it for what it really is – a vital component of any retirement planning strategy.