About that pensions pile-up down the road…

RoxDeathHave you ever been in a car crash? You know that sickening moment when it becomes clear something very bad is happening? I had that moment reading this.

Retirement income specialist MGM Advantage has revealed the true cost of inflation and how it will affect retirees’ income over the coming years.

Of the 400,000 people retiring each year who purchase an annuity, 90% choose a level income.

If inflation averaged 3% over a 25-year retirement, the real value of income reduces by 53%, collectively wiping £6.3billion off retirees’ purchasing power over that period.

MGM Advantage considers this a conservative figure and has based this on people retiring this year with an average pension pot of £33,000, choosing a level annuity with no escalation or index-linking. Andrew Tully, MGM Advantage, said:

“These figures show just how damaging inflation can be, wreaking havoc with people’s pensions and wiping thousands of pounds off their income over time. “People close to retirement have some very tricky decisions to make when looking to convert savings into retirement income.

With record low annuity rates the obvious solution could be to shop around for the best starting income you can find.

People talk about the damage that Quantitative Easing has had on savings and it’s true it has depressed interest rates to nugatory levels, but interest rates were never meant to keep pace with inflation.

But nobody ever suggested that the long-term cost for the Government would fall below the rate of inflation. But that is what Quantitative Easing has done. It’s meant that you are lending your pension savings out with the prospect of a lifetime return so low that the cohorts of annuitants from 2009 through to 2014 will have “never had it so bad”.

The idea behind investing in an annuity is to get more than your money back . You are offering a mortgage to the Government (or organisations with super-high credit-ratings) and they agree to pay you the money back over the rest of your life.

But the cards are stacked against you. Whereas you have the money, it’s the borrowers who have the clout! You have to pay as a reduction in your income for the costs the borrowers incur in setting aside money in case you live too long and in case they run out of money!

To make matters worse, unless you prove otherwise, the people who are borrowing money from you, will assume you will live for ever (well into your nineties) unless you can prove to them there’s good reasons you won’t.

So many annuitants won’t get their money back. QE is one problem, an over-cautious approach to insuring guarantees is another, and the crazy side-effect of EU legislation on equalising men and women’s annuity rates is a third. These are systemic problems with annuity purchase that people retiring today can do nothing about.

But despite all this, there are ways that people buying annuities today can fight back and get themselves a fairer deal. The real car crash is that well over half of those buying annuities are still not giving themselves a chance. They are lending their life savings to a borrower who is setting the rate at which the money is repaid ON ITS OWN TERMS!

Watching literally hundreds of thousands of people doing this every year in the last five has been like watching the biggest motorway pile-up Britain has ever seen!

So here are some top tips for retirement:

* Shop around for the right income option for your personal circumstances, and always try to secure the best annuity rate;

* Consider enhanced annuities if you have a pre-existing health or lifestyle condition, which can add up to 40% to your income;

* You can inflation proof your income by choosing an escalating annuity – but often you will find the starting income is significantly lower than other options;

* Consider alternatives such as investment-linked annuities, which invest in equities and other asset classes providing a hedge against inflation, although this comes with a level of risk;

* You could consider delaying taking your income if you can afford too, in the hope annuity rates or investment returns on your savings improve your income. However, this “cost of delay” from the lost income is never likely to be recovered in your lifetime;

* Those with larger pension pots could consider income drawdown, although again, this comes with a level of investment risk;

* You could adopt a “mix and match” approach, using a conventional annuity to secure an income while using the balance of your retirement pot to purchase an investment-linked annuity, which can provide a hedge against inflation with potential for investment growth and therefore growth in income.

All of these tips are good ideas. But they don’t get round the systemic issues with annuities which are not going to go away.

People in Britain know that guaranteed annuities are not the mass-market solution they are being sold as. They know that there are better options out there which is why so many people refer to private pensions as a “rip-off”.

In Holland , people get 39% more pension for their savings than we do in the UK and it all comes down to doing things collectively.

It’s crazy that I have to talk about “fighting back” against the people who are borrowing money from you. It’s crazy that the whole financial system is stacked against the annuitant and it’s bizarre that in 25 years of operating these personal pensions, virtually nothing has been done to address the systemic inadequacies of the decumulation system known as “guaranteed annuitisation”.

The Government is at last addressing these issues, it is promising to follow up on collective DC and start offering large DC schemes the opportunity to adopt the best features of the Dutch, Danish and Swedish systems (which work better than ours).

But until something is done to turn good ideas into action, car will continue to pile into car and the havoc will blight the rest of the lives of those caught in the crash.

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly and the Pension Plowman
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