When I first read the PLSA’s 2022 update on their “retirement living standards” I queried the cost of securing the balance between a minimum , moderate or comfortable retirement income and what people are likely to get from the state pension.
So I contacted my friend Mark Ormston at Retirement Line to get some indicative costings and to neither of our surprise, the answer depends. It depends on how much inflation protection you buy and of course it depends on your state of health, where you live and other factors used by annuity providers when they offer you a quote.
There isn’t space here to explain fully how the Retirement Living Standards work nor to go into important differences between the need for personal and household income (or their impact on benefits).
But Mark and I thought it would be interesting to dig a little deeper than the PLSA had, when simply offering one annuity conversion factor at £6,200 pa for every £100,000 you’ve got in your pension pot.
The slideshow above has been created by Mark who is keen to point out that he did this himself, for my blog and this is not a Retirement Line production! I suspect that Retirement Line will be proud of it nonetheless.
So what does Mark’s work tell us?
The technical details of what Mark is quoting are on slide 2 which you can read at your leisure, here is the first insight
If all you want is the minimum income standard – the one that keeps you heating and eating, you need to find nearly £50,000 to buy an extra £2, 200pa from an insurance company. You can do it cheaper, but that’s (almost) the equivalent – the state pension gives you even more inflation protection but let that be.
In his work with Steve Webb, Mark became aware that many people currently do not get the full state pension. So he looked at the cost of topping up from the private market if you only got 2/3 the state pension – the bill goes up from £50k to £125k. As a very rough proxy, this extra £75,000 could be considered the value of pension credit (in this case). Latest figures suggest that 850,000 households aren’t claiming pension credit – though entitled to, that’s around 1/3 of all eligible.
For people on low incomes with low capital, there may well be a way to boost state pension (where you don’t get the full amount) for free or at a much cheaper rate than buying an annuity. Read this.
Now in nominal terms , the difference in buying an inflation linked and a level annuity for a minimal top-up isn’t that huge. And frankly most low earners aren’t going to be able to afford to buy a gold, silver or bronze plated annuity, they are not going to be able to afford an adequate annuity at all.
But for people reaching 66 who want to see their pension providing them with a moderate standard of living, the disparity between the cost of a level and RPI linked income is very material.
This is very real world. Very few people who consider themselves moderate earners in their working careers will have £173,500 to buy a level annuity, let alone £278,000 to buy the inflation protected version.
And here’s the cost if you have got a pot of a private pension but you haven’t got a full state pension.
The cost of losing £3,500 of state pension is around £77,000. If you have that amount knocking around by way of tax free cash, savings, or even some tax-efficient drawdown, you should be considering buying extra state pension credit – an offer which is open to all but will partially close to some in April this year.
So what if you want to be better off in retirement?
I suspect that those with aspirations to have a moderate income will fall into two camps, those who have a hope – because they have a realistic DB pension and those who have a prayer – because they are relying on your DC pot.
For people who want to have a decent retirement , the need for a proper pension from your employer(s) is even greater. Even fewer are going to have the money to buy an annuity to secure this standard of living.
Here the cost of indexation is over £200,000 and I suspect that most moderately wealthy savers will look at that and say “I’m not paying that”. You can of course buy a level annuity but remember that would have meant you seeing a 10% inflation adjusted fall in income this year.
DB pensions, which are likely to do much of the heavy lifting only provide partial inflation protection , unless you are in a public sector pension scheme where you are getting the equivalent of an RPI annuity. Most people in corporate DB are capped on 5% of 2.5% so the 3% increasing annuity is closer to what they get.
And here for completeness is the cost of securing a comfortable lifestyle in retirement if you have only 2/3 state pension.
Most of these people will have financial advisors, if you are such a person, have you discussed with your advisor the options you have to top up your state pension credits by the end of April – if not – why not?
The costs of securing any kind of these income levels are staggering relatively to the ambition of the income. For many people, any of the figures in the annuity income boxes will be out of reach.
The fear is that this leads to despair, encashment of pots and a sense that pension saving is windfall saving and not about replacing income at retirement. And remember that all these figures relate to people who are waiting till 66 to get their retirement income, the figures are a lot higher if you go earlier.
So people need to flex their thinking and plan to take more risk and more income or cut down their expectations – or work even longer.
The conversation I have with myself and others is whether there is a better way of securing retirement income than an annuity. To about 10% of us, the answer to that seems to be “no” – they are the ones who use their pots to buy annuities – though rarely fully inflation protected.
To buy inflation protected income in retirement, I suspect I will have to take more risk. That means either having to do the pension thing myself through drawdown (or paying an adviser to do it for me) or it means waiting till a new kind of annuity comes along – one that I can afford!
And now you can see why funding DB pensions with bonds is not a sensible strategy for corporate UK, as it will be so enormously costly. Annuity purchase is far more expensive than other ways of securing long-term income and also enables some growth. DB schemes need to take risk to earn upside and higher returns than ‘safer’ or supposedly top quality bonds. This lies at the heart of the current conundrum and the UK is wasting hundreds of billions of pounds which could be far better used to invest in productive assets earnings better than bond-returns, but taking more risks over the long-term. UK plc has spent billions on trying to buy annuities instead of trying to build growth for their pension scheme, society and the economy more widely. DC is not taking up any of the slack and I believe part of the reason for our economic underperformance (aside from Brexit) is the lack of domestic institutional investment for risk assets and growth projects. The past ten years of more have seen our largest pension funds shying away from equities and other growth assets in the name of LDI/downside protection. Annuities are the most expensive and least productive way to deliver pensions.
I feel as if this notion should be queried. If a DB pension provides an income stream of 1pa until death, then an annuity that provides the same income costs exactly the same as the DB pension. If the benefits are the same, the costs are the same. Now, how that cost is funded by the provider can vary substantially. Obviously there are different ways of investing to mitigate the risks. Alternative styles of investment reflect differences in the provider’s decisions but do not affect the benefit and therefore do not affect the cost.
One other point: for a pool of people, annuities (and DB pensions) have the substantial advantage over a DC arrangement that assets are not ‘wasted’ on early deaths. That is, to get everyone in the pool the same income until death, annuities are one of the most efficient mechanisms.
Since the early 2000’s companies have used cheap money to use to finance share buy backs. CEO’s see the career opportunity as short and need to make money fast so they use the buyback to cash in on options robbing the company of future capital to grow the company.
Productivity declines and the country gets poorer. No productivity no services Add Brexit, add a pandemic and you have the perfect economic storm.
Public service pensions, according to a recent Pensions Minister, are unsustainable.
LDI sold by unregulated representatives has yet to be quantified. I guess that £500bn was wide of the mark. Where is the compensation coming from?
RPI at 14% in November let’s see what the figure is on the 18th
A long list of concerns John, but we have to live through this
Long list only because no one will face the real issues
Which one should we solve first? How about productivity so that the U.K. can pay for what it thinks it deserves
So a pot of £581,500 can buy an RPI linked income of £26,700/year. This is about 4.6% which is higher than the Safe Withdrawal Rate (SWR) from investments of 4% which is often touted for draw-down like scenarios. A number of commentators are now suggesting 4% is too high and should be reduced to 3.5% or even 3%. That rate I believe is aimed at a 30 year withdrawal period and aims to have some kind of residual value in most scenarios. On that basis though an RPI linked, no-worry annuity returning 4.6% seems like a no-brainer. What is the “typical person” on which these numbers were calculated (other than being 66 years old with a PE postcode)? I think I’m missing something.
The disease not the symptoms need to be addressed.
Productivity is vital for achieving a healthy financial state without compromising living standards. It is the key to increasing incomes above expenditures and managing debts effectively.
By improving productivity and distributing its benefits equitably, we can foster economic growth and reduce inequalities. Pursuing cost-effective strategies allows for a double bottom line—financial viability and social good.
Emphasising education, innovation, and a supportive business environment are crucial. By embracing productivity as a catalyst, we can create a prosperous and sustainable future.
Lazy money gets lazy returns. Fund managers have had their time in the Sun, Are they really worth the hire?