Despite the Chancellor stating his intention that most retirees would no longer need to purchase an annuity at some stage in their later life, it remains my belief that they still have a place in people’s retirement plans.
It was therefore very interesting to read David Blake's discussion paper on behalf of the Pensions Institute entitled 'The consequences of not having to buy an annuity.' He makes the very good point that the planned changes will transfer greater risk to the retiree and away from the insurance companies who provide annuities. With risk, in most cases, already having been transferred to the individual in the accumulation stage following the demise of final salary pensions, this further transfer in retirement could prove a problem. This is particularly true where the individual fails to understand the complexity of what they are being asked to do.
There are many variables that come into play at retirement and all will affect future financial plans. These include investment returns and the pattern of those returns, as well as inflation and most importantly how long the retiree and their dependants are going to live. Whereas with an annuity purchase, all these risks are taken on by the insurance company – something they can do by pooling many investors – it is much more difficult for the individual to do so with any level of certainty.
Ignoring all the other imponderables and just looking at longevity illustrates the difficulties. Life expectancy has increased by two years per decade since 1840 and expectations are that it will continue to do so. In David Blake's discussion paper, the best current estimate for a male aged 65 in 2060 is 26 further years of life, but even within this estimate there is a wider range between 22 and 28 years, thus indicating the difficulty of forward planning.
"As age increases and the wish for more certainty becomes a driver of financial decisions there will be a time to start the annuity process. The difficulty is deciding when."
According to the discussion paper, men tend to underestimate their life expectancy by about five years and women by about three, so that is never a good start. Even if you have the right estimate of life expectancy – and here bear in mind that, as the paper points out, even the Office of National Statistics has significantly underestimated the increase over the last 40 years or so - what does that really tell you? If a current 65 year old male retiree is told that his life expectancy is 86.7 years there is around a 50% chance that he will, in fact, live longer. Getting it wrong will potentially mean running out of money, or indeed having too much left over at death, some of which could be subject to inheritance tax charges.
It will for most therefore be sensible at some stage in retirement to transfer this risk, at least partially, to an insurance company via an annuity purchase. With a shrinking annuity market and the move towards full underwriting, purchasing an annuity in the early stages of retirement when you are healthy is unlikely to be the chosen option for most. However as age increases and the wish for more certainty becomes a driver of financial decisions there will be a time to start the annuity process. The difficulty is deciding when.
With all the complexities of such long-term planning this is not a journey to take alone. The Government's intention of providing guidance at retirement is likely to be wholly inadequate for many individuals.
Circumstances and objectives will change over time and having a financial expert to hand who can help make at least some sense of the many variables will be vital. That is something that retirees will need to consider and pay for as part of their retirement plans, or they could find themselves facing old age with very little in the bank if they get their sums wrong.
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