Written by Malcolm Small on Thursday 19 December 2013
The Financial Services Consumer Panel has published a paper on the annuity market in the UK, and it does not make comfortable reading. Buying an annuity is the way that most people convert their Defined Contribution (DC) pension fund into a regular income when they retire. However, the report finds extensive evidence of failure in this market, with people buying the wrong type of annuity, or poor value annuities, with widespread confusion around the range of choices open to them. Those with modest pension “pots” will find it difficult to obtain financial advice, and if they can find it, it is likely to be uneconomic. Thus, they are left to find their own solutions through comparison web sites and unadvised sales. In many cases, they struggle. Worst of all, once they have made their choice, that’s it. Regulation, and the very way annuity mortality cross-subsidy works, mean they will not get a second chance, and will have to live with the consequences of a poor decision for the rest of their lives.
There are deeper challenges even than this. The upside of an annuity is that it should provide you with an income for life, no matter how long you live. However, an annuity dies, usually, with the annuitant, so if you don’t live very long after taking one out, they can provide very poor value for the fund invested. Low to moderate earners, the very people automatic enrolment into pension saving is intended to serve, are at particular risk of this happening to them. Annuities, by definition, provide income in a “linear” form of regular, level, monthly payments which do not readily cope with expenditure which in reality are “spiky”, with needs to replace cars and care home fees poorly served, for example. Even in a predictable retirement, income requirements are typically “U” shaped with needs for higher income at the beginning of retirement, and deep old age, typical.
Annuity purchase has been at the centre of thinking particularly at HM Treasury, where the quid pro quo for receiving tax relief on contributions was the requirement to secure an “income for life” in the shape of an annuity, to avoid “falling back on the state”. Some liberalisation has occurred in recent years around, for example, “flexible drawdown”, but the regulatory mantra from Canary Wharf is that annuity purchase must remain the default for those with more modest pension pots. However, is it not at least arguable that, as there will be very little “falling back on the state” in a future dominated by a flat-rate basic state pension as a right, we should recognise the need for people to access their pension fund in ways that suit them? We need to revisit the way retirement income works, before the wall of money that will hit the market as the baby-boomers retire, arrives.”