Financing Retirement: Annuities are not the only option
Written by Paul Dodd on July 28, 2015.
Recent research commissioned by The Telegraph has painted a
bleak picture for those saving for their retirement. The challenge facing them to secure a reasonable income to live off during retirement becomes ever more tough as interest rates languish at record low levels while life expectancy increases at its fastest rate ever. According to figures from the Office of National Statistics, while in 1984 the average 70 year old man had a life expectancy of 82, he now needs to make his savings last a further 7 years until he turns 89.
Most people who don’t have a company final salary scheme have traditionally purchased an annuity on retiring. According to the Association of British Insurers 353,000 retirees did this in the UK in 2013. The advantage of an annuity is that it secures a pensioner an income until they die, whenever that may be. They don’t have to think about how much income to take from their savings each year and they will never run out of money. Of course, someone who sees in their centenary will be getting a much better deal than the individual who shuffles off this mortal coil at 75.
However, there are some major disadvantages to purchasing an annuity. Annuity holders lose all control over their money and the access they have to it, many die before their money is returned to them and the remainder is lost to their heirs. Perhaps more worrying is the rising cost of purchasing an annuity. The Telegraph study estimates that the cost of each £1 of retirement income has gone up from £5.10 to £11.90 over the last two decades.
In addition, insurers operating annuity schemes have been lambasted for exploiting retirees with few other options at their disposal. Criticisms include the mis-selling of contracts not fit for purpose, contracts offering poor value-for-money, and, perhaps most importantly, slashing payout rates. In 1990 a 65 year old in good health could expect payouts of £15,000 per year on an annuity of £100,000, in 2014 this has dropped to just £5,500. The reason for this is that insurers have grossly underestimated just how dramatically our life expectancy would rise as a result of medical research and healthier living and in order to protect profits they have had to cut annuity rates. Their investments have also suffered from the prevailing market conditions with low interest rates damaging their returns.
The Telegraph found that the best annual return on a £100,000 annuity for a 70 year old man would be £6,895 per year and that in order to see a return on that capital, the purchaser would need to reach the age of 85. Legal & General have estimated a return of 4.1% per annum for a retiree living to the age of 90 rising to 5.4% if they hit the big 100.
To those feeling short changed, the relaxing of legislation relating to pensions
revealed in the 2014 budget last month will come as welcome news. George Osborne announced that savers will have more flexibility regarding their pensions with the option to access a tax-free lump sum as well as freedom of choice as to how to invest their retirement savings.
The market for annuities faces a huge shake-up as a result of this new pension legislation. A drop in take-up of 50% has been predicted by some, although the effects of this on the cost of an annuity and its payout are the subject of much debate.
Those deciding to opt out of annuities, will face some of the same dilemmas as the annuity fund insurers. Without a crystal ball they do not know how long they will need their savings to last them, the source of much debate in the UK at present. Some experts are predicting that many people will invest their retirement funds in alternative ways mixing and matching products and strategies depending on their health and the stage of retirement they are at. Perhaps stock market investments will be favoured early in retirement when an individual’s income demands will be higher and they are capable of monitoring their investments, but they will switch to an annuity further into their retirement when a secure income becomes more important as they age.
What becomes clearer and clearer by the day is that the onus is on each of us to work out our pension requirements and how to meet them. The first step is to ascertain your own personal aspirations for your retirement and how much income you will need to fulfil them. You may wish to take luxury holidays and indulge expensive hobbies, or you may be happier leading a simple life close to family and friends. Your retirement strategy should reflect this.
While an annuity may be the best way to go, in many cases it is definitely not and other options exist, particularly for expatriates. You may well find that other routes such as an offshore pension will provide you with a far better return. The task of working this out is not for the fainthearted and this is where a professional financial advisor can come in. They can explore all your different options with you and help ascertain the best strategy for you. You may have spent decades building up your pension pot, it is worth taking a little time to work out how to get the best value for money from it, and secure yourself a financially comfortable retirement.