Learning how to buy pensions.

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Mark Ormston who works for Retirement Line has written an excellent blog on linkedin. This is my version of his blog.


Are people taking sub-optimal annuity decisions?

The figures in the circles are  taken from the FCA Retirement income data report for the period April 2018 to March 2019 –  and come as no surprise to Mark and his team.

Mark asks

“Why is the take up of these valuable annuity options so poor?”

His conclusion is

“Simple – Cost”.

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Is this mis-buying or could we be “selling” better?

Financial Advisers – who are little involved in annuities – will point out that many people buy inadvisedly and that they’d be better off buying through them. Most annuities are actually bought off the page – or at least via Google and that may be because of product bias amongst IFAs or it may be because people who buy annuities are the kind of people who try to disinter-mediate.

These are typically independently minded people with a decent level of “financial capability”.

I don’t think that anyone is setting out to misinform the public, but after thinking about Mark’s blog, I think there are aspects of retirement decision-making which could and should be revisited. That’s what this blog attempts to do.

 

Solving the “what if I die too soon” problem

Many people who investigate annuities are put off by the thought that they are disinheriting their family with the annuity purchase. This is a particular worry for people who worry about dying soon after buying the annuity. It is possible to insure against losing the purchase price of the annuity by buying “value protection”.

Mark has done some sums.  His numbers are based on a healthy 65-year-old male with a £100,000 pot.  Here’s his conclusion

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Remember, this person has an entitlement to 25% of that £100,000 can be taken as tax free cash so what Mark is suggesting is that by buying value protection , the consumer is insuring that the full value of the annuity is paid out if the annuitant lives and the balance between what has been paid so far and the annuity is returned to the family as an inheritable lump sum.

This is an entirely new way (to me) of thinking about the annuity as both a protection against living too long and an insurance against dying too soon.


Solving the escalation problem

Mark tells us  there ‘s plenty of consumer interest in the more expensive annuity options, especially in escalating payments, an option that’s  frequently quoted and usually dismissed when its impact is understood. Anyone who’s been involved in programmes offering pension increase exchange (PIE) will know how ready people are to swap indexation for jam today.


Can we afford not to escalate?

I speak as someone who did not take the tax-free cash on offer when I drew my pension. The main reason I didn’t was that I was being asked to swap 3% escalating income for cash at an extortionate exchange rate.

Mark points out that the typical conversation he has with people assumes that tax-free cash is sacred

Q.    ‘Would you like to take out 25% of your pension savings free?’

A.      ‘Oh – Yes please’

As a result, the tax-free cash is taken out of the equation and we all buy  level annuities.

But reinvesting tax-free cash in the annuity purchase could have partially restored the escalation to the annuity  and Mark’s point is that this conversation is not being had. For many people who are looking for a real wage in retirement, tax-free cash is simply not what is needed.

I know that advisers will pick up on the fact that pensions annuities are taxed and that there are ways of getting the tax-free element of the pot paid out through drawdown.  I know  that there are plenty of ways to generate tax-free income from ISAs , but the point Mark is making is that if a client is coming to him for income, he may not need a cash lump sum at all.

Many people are being talked into a course of action that is just not what the customer ordered. Customers who live long , may well regret their escalation, when the cash is gone.


Protecting your partner

The third of the three issues the FCA have highlighted is that most annuities are purchased on a single life basis. The numbers of married couples in retirement suggests that many spouses are not protected from living longer than the person buying the annuity.

In almost every case there is likely to be enough money in the tax-free cash to make sure that the annuity is paid out for as long as is needed by the surviving spouse (eg till the second death.

In all three cases, tax-free cash can be used to overcome the problems normally associated with annuities.


Let’s learn how to buy pensions!

I’m grateful to Retirement Line and particularly Mark Ormston. Every time I speak with Mark I get a fresh insight into the retirement decisions he sees people taking and he teaches me new ways at looking at old problems.

Of course there are some fundamental issues with annuities which will put many people off them, chiefly their cost at a time of depressed interest and gilt rates. While this can be partially mitigated through the purchase of fixed-term annuities, an annuity is not right for people comfortable with market risk. But there are many people who want the certainty that annuities bring and I don’t think the simple messages in Mark’s blog are being properly disseminated.

Retirement Line aren’t financial advisers (though the firm is authorised by the FCA). They offer complimentary conversations to those people have with financial advisers. Many people who speak to financial advisers go on to speak with Retirement Line and get both perspectives.

I am learning and I think many advisers could learn a lot from Mark and his team. I think that many occupational pension scheme trustees should be speaking with them too!

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About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in advice gap, age wage, annuity, pensions and tagged , , , , . Bookmark the permalink.

2 Responses to Learning how to buy pensions.

  1. John Mather says:

    Amazing, few seek advice (6% is often quoted here) Group A

    The ones that don’t have poor outcomes. Or so it seems but since they did not take advice it has nothing to do with the IFA community

    Those that do take advice are assumed to be wealthy or at least not in
    financial trouble. Probably true Group B

    Maybe there is a correlation here.

    What is the break even point ie when you have all your capital back
    for an Indexed annuity for a 65 year old assuming a range
    of ages at death? Assume good health and a non smoker who is not obese Group B They probably also took Health and nutrition advice as well

    Compare with drawdown taking the “natural income”

    Who should buy the annuity Group A or B

  2. Mark Meldon says:

    As a small IFA, it often amazes me as to how few people take regulated advice when considering the critical area of deciding what to do with retirement funds, whether DB pensions, DC pensions, drawdown v annuity or a combination. I’m sick of meeting new widows or widowers whose spouse/partner bought a single life annuity, for example, “off the page” as we used to say.

    I’m very fortunate in that many of my firm’s clients have a combination of financial assets from which to draw income, whether a ‘natural yield’ or some mildly artificial construct using some reasonable assumptions about future likely returns (hint: negligible) from a diversified pot of assets.

    Many are in the luxurious position of having legacy DB pensions, their state pension, and a decently sized DC pot, too. They also have cash reserves, ISAs and, maybe, other long-term investments such as stock portfolios and investments bonds. A good IFA can help plot a course, securing ‘basic income needs’ on a guaranteed basis via DB pensions and annuities (not forgetting life assurance for those with single life GAR pensions), but that is only an option for those who have such wealth.

    The problem is, most people don’t have such assets. I regularly meet people with very poor prospects for a long an happy retirement. That might be because they are in poor health or in debt. They might only have the state pension and a modest DC pot to look forward to. Many of these people are dumbfounded when I point out to them that they bear all of the capital risk and costs of their DC pot and that, unless they work for a very enlightened employer, they are pretty much on their own when deciding what to do. They don’t know what to do as they are not ‘pension experts’.

    These are the people I like working with the most, as I can see that a good IFA can add real value to their lives for modest cost. Most are ignored by IFA’s or are too nervous to approach one – this is wrong.

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