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The death of guaranteed income for life retirement solutions has been greatly exaggerated, argues Stephen Lowe, before offering six reasons why there is plenty of life in them yet.
It has been suggested we are hearing the death knell for ‘guaranteed income for life’ (GIfL) retirement solutions following the withdrawal from the market of some providers – albeit ones with very small market shares – hoping there may be better business opportunities elsewhere.
It is easy to be pessimistic. A low interest rate environment and Solvency II have not been helpful for the returns available on guaranteed income plans. Yet despite it all, most retirees still have a fundamental need for a stream of income that will see them through a retirement likely to stretch decades into the future.
Pension freedom is exciting but so far there have been no new miracle retirement products launched that can do what an annuity can – provide the peace of mind a retiree can spend that income today knowing with certainty that they will get ‘paid’ again tomorrow.
What the new rules highlight is that the government has judged people only need a finite amount of guaranteed income to keep them out of the threshold of State support – ideally enough to cover essential spending. The state pension will go some way towards this although full entitlement – and there are millions who have only partial or no entitlement – is only a few pennies above the basic poverty threshold. That needs to be topped up by income from work and private pensions.
True pension freedom
In reality, it is only when you have the firm foundation of sufficient guaranteed income to pay the bills that you have true pension freedom to spend, save or give away what is left.
Professional advice has focused on how to use existing products more creatively in the new environment – to find the best blend of flexibility and certainty by combining good value drawdown with the most competitive guaranteed income the market can provide.
Pension freedom is great if you know what you are doing or have a professional adviser. The big problem is that ‘mass market’ or ‘Middle Britain’ pension savers, who need to make the best use of their pension money, often cannot afford to take much risk, will not pay for advice and, in many cases, even refuse to accept free guidance.
Paradoxically, while some do not want to buy this maligned product called an annuity, they often do want to know their income is guaranteed and is not going to disappear and leave them reliant on the State.
The government is well aware of this paradox. The success of its efforts to expand access to advice is crucial because it knows mass-market, non-advised drawdown that allows people to take chunks of pension money when they like, while still leaving them vulnerable to market shocks, is a potential disaster in the making.
Although it says there is no strong evidence material numbers are either under or over-consuming – hoarding or squandering – there is also no evidence people are making conscious and considered withdrawals. The results of this experiment are years, even decades, away.
That is why we have been calling on HM Treasury, the Financial Conduct Authority and the Department for Work and Pensions to strengthen their data collection to try to create a better forward view of what might be the outcome for different groups of people.
To counterbalance the negativity around annuities, here are six reasons why there is plenty of life in GIfL solutions and will be for years to come:
* Annuities were invented to turn capital into income in an efficient way while minimising risk to any individual. New pension rules may give individuals more flexibility over how they invest or access their own funds but, by acting individually, people will need to be very cautious how much they spend and even the most miserly are still at the mercy of events.
* Retirees need income to pay the bills for as long as they have bills. For the average retiree today, that is likely to be around a decade longer than their parents, many of whom are still alive. Uniquely, GIfL provides certainty of income with no active intervention required and still works if cognitive function deteriorates in later life.
* Oscar Wilde may have observed a cynic is someone who knows the price of everything and the value of nothing and yet, if he were alive today and reading the personal finance pages I would like to think he would marvel that GIfL providers are willing to offer such generous returns at a time when the world is undergoing such rapid economic, political, technological and medical change. Would you or your firm be prepared to take on the risk of paying someone a regular income for the next 30 or 40 years?
* Returns on an individually underwritten GIfL are a realistic reflection of what income a pension fund can deliver to that retiree over the long term. Taking a higher income from a drawdown fund than available from an annuity is a hugely risky strategy. And for someone with a mild health issue, the uplift in annuity income from underwriting could easily be equal to having a pension fund worth many more thousands of pounds. It really is like free money.
* Not all retirees are afraid of investing but, unless income is guaranteed, then it is at risk. Of course, investors who have a foundation of secure income to fall back on can invest the rest as adventurously as they like knowing they have protection in place if their gamble does not pay off as they hoped.
* Finally, the new pensions rules help address the hoary old criticism of annuities that your capital disappears when you die. It has always been possible to protect the capital, but today’s modern annuities offer the option of extended guaranteed periods or value protection that can ensure every penny originally invested is repaid even in the event of premature death.
In a nutshell you might say that drawdown is for optimists while GIfL is for realists. Most retirees, however, are likely to be a bit of both. Pension savers are getting the message that pension money is their own money. Hopefully, before it is too late, they will also hear the message that it needs to last a lifetime.
Stephen Lowe is group communications director at Just Retirement
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