Greater income certainty is one of the major outstanding challenges for the pension freedoms
“We’re inching ever closer towards a crossover when more people will be relying on defined contribution to fund their retirement than defined benefits. As today’s PPI report highlights, the challenge this creates in ensuring people reach the right decisions cannot be underestimated.”
PPI modelling highlights that although no two retirements are alike, annuities can play a crucial role in maximising retirement income
“Whilst people may access their retirement savings for a broad range of reasons, such as to meeting one-off costs like repaying their mortgage, the modelling shows that often, using an annuity is the best way to optimise total income. The analysis also helps to quantify the trade-offs between taking an annuity early, where income will be paid for longer, against taking one later, where the rate of income paid will be higher. The more appropriate course will depend on an individual’s situation. An attractive approach may well be to match fixed outgoings with guaranteed income initially and to fully annuitise at a later age.
Behavioural biases play an important role in shaping retirement income decisions
“As we know, decision making is seldom rational. The report reminds us how true this is when people are making retirement decisions. It highlights that - for understandable reasons - people often underestimate their own life expectancy and the possibility of cognitive decline, which leads them to full drawdown rather than incorporating an element of annuitisation, which may well be more appropriate.
Guidance and advice are important in optimising retirement income and area for potential reform
“Given the potential for bad outcomes, guidance and advice are crucial. Research sponsored by Phoenix Group has found that only a fifth of 50–64-year-olds have spoken to a financial adviser about their pension, highlighting the widely known advice gap. The support on offer to those approaching retirement has rightly been an area of focus for government.”
Value of annuities shines through, as does the potential for further product innovation
“Annuities can help take the uncertainty out of retirement and as the PPI report highlights, are often the best way to optimise total income. Recent stock market volatility and the return of inflation underscore the huge value of secure income to customers, particularly as rates improve. So far this year, annuity rates have improved by over 25% which is a trend that looks set to continue.
The key thing is how much to annuitise and when, rather than whether to annuitise or not.
“We’re seeing innovation internationally as the world moves to DC – given the uniform challenge of managing retirement income and increasing longevity in a volatile economic climate. In Australia for example, the Retirement Income Covenant now requires schemes to offer a degree of guaranteed income, with the option to keep funds invested and the ability to make flexible withdrawals.
This kind of thinking highlights the scope for further ideas in the UK, and we expect new demand for solutions that speak to the whole of retirement, incorporating the best of drawdown and annuities.”
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