Annuitisation; it shouldn’t be a secret
In last month’s article I said retirement advice doesn’t have to be black or white because there are solutions that bridge the gap between annuities and drawdown. I went on to say that I thought it was difficult to innovate annuities there was plenty of scope to innovate the way advice is delivered.
I was very pleased to get a response from Peter Ellis at Just Retirement. He made two important points. First, he said that he was more enthusiastic about product development. Secondly, he called for a more open-minded approach to the way advice is given so advisers can wean themselves away from the black and white approach and recognise there is room for shades of grey.
I was so pleased to receive this response because apart from showing that people read my articles which makes the effort worthwhile, it prompted me to think what can be done to promote a more open-minded approach.
One way of doing this to talk about annuitisation as a concept rather than an annuity as a product. Or to put it another way, rather than thinking of annuities as simple products that you shop around for the best price, we should think about the positive advantages of converting pension pots into income for life.
Economists, especially those in the US, have been interested in the concept of annuitisation (the process of converting a lump sum into income for life) for a long time and have argued that those who want to find the best way to stretch their income over their lifetime should purchase an annuity. Economist talk about the annuity puzzle; “Why, if annuities provide the optimum income payments for someone who wants to maximise their lifetime income without taking risk and ensures they do not outlive their income, do many people favour higher risk drawdown options?
The answer to this riddle is twofold. First, many people are reluctant to make irrevocable decisions, and secondly there is a reluctance to choose an option that does not pay a lump sum to their heirs. We can add now add a third reason; pension freedoms.
However, the grass is not always greener because drawdown may not provide the same income as an annuity and there are significant risks.
The best case for annuities I have come across was in a US publication called Annuitisation; it shouldn’t be a secret. This has some powerful arguments why people should take lifetime annuities more seriously and made the following observations;
- Many people are concerned about their pension income and risk of outliving their financial asset
- There is a strong desire to preserve one’s standard of living in the long-term
- Many older people want simplicity and structure in their financial affairs
- They are coming to grips with their own mortality and expressing concern about the desire or ability of a surviving spouse to manage money in the event of their own death
The paper went on to give many reasons why investors in the US don't take annuities more seriously:
- The benefits of annuitisation are not sufficiently emphasised
- There is a desire for flexibility, control and death benefits
- There is a mistaken belief that the same goals can be achieved by a systematic withdrawal from a mutual fund (drawdown fund)
I think this last point is the most important. When annuity rates where much high it was certainly a mistaking belief, but with annuity rates still close to all time lows, it is easier for drawdown to re-produce annuity type income. But if rates go up and equity markets go down annuities will once again become a hard act to beat.