This morning is the first work morning of 2025. Good luck on your wake up! I am not quite ready for work but am easing myself back with my blog which people seem to be enjoying.
Some are finding my thoughts contentious and one (Byron) wants more debate. The question is fundamental. I am arguing that pensions and annuities are different things. People like pensions but don’t like annuities. Legal & General have got under my skin by calling their annuities “pension annuities”.
Philip Geddes has made some pertinent remarks in support of L&G’s position and they are published on linked in
Now I think that most people would agree with Philip Geddes that an annuity is a guaranteed series of payments and that a “pension annuity” suggests that the annuity is a kind of pension as it pays out for as long as you are around, or indeed you and your partner- depending on what you choose to buy.
So why do people like pensions and why do they dislike ” annuities” and why do I dislike annuities taking over pensions by the use of “pension annuities”. Here is what Byron says in the comments on this blog
Philip Geddes over on the LinkedIn version of this blog says “Having something that looks and feels like a DB pension but has investment upside with no downside seems wishful thinking.”
Philip’s background as a professional in tax before his own retirement may make him
biased to say exactly what he’s written there.I think you may instead be desiring “something that looks and feels more like a DB pension, but is a pot of savings which may yet have investment upside, although there may be downside too”.
The value of a member’s pension in DB is usually effectively halved on death, and state pension for widows or widowers is similar at best.
Keeping your pensions saving in, for one example, a SIPP, on the other hand, means you could still have some investment upside but also have to live with downsides.
But you can draw down as and when you require, more often in lumps perhaps, rather than by regular monthly instalments?
After death, what’s left in a SIPP is now to be taxed before being redistributed. But unless all of the investment fails that’s still more than zero in a DB or state pension after both member and partner dies.
Life’s expenditures are a mixture of regular monthly (eg day-to-day living expenses) and lumps (cruises, weddings, parties generally, replacement assets, etc.)
Some of us may be confident, yet realistic, enough to ride the bumps of the roller coaster using draw down, while others require the certainty (but the lower value in the hand) of an assured solution.
Which is it to be, Henry? You decide.
Thanks for letting me decide, I think that offer came from Byron but it is a hugely important decision in people’s lives if they have a DC pot. People are sold a pension and a pension is what they expect. Those with pension pots can’t (generally) transfer their “pension pot into a pension fund” and get a pension.
You can in certain circumstances buy pension from the Local Authority with cash from a pot.
Most people have money as savings that they can draw on to meet the big bills (mentioned above). Most of us have a private pot or entitlement that we can exchange for a tax free cash sum which adds to the bank of money we draw on to pay the unusual bills. It is roughly a quarter of the value of the pension that can be drawn and usually 25% of the pot value that can be exchanged.
This money drawn is never referred to as a pension, it is the money that people have taken instead of a pension. Many people choose to draw more than a quarter of their “pot” and pay tax on the taxable part, some choose to mimic a pension by setting a drawdown rate they consider right for them.
They are either “confident” or mimicking others or simply drawing what they need and hope for the best. There is very little information on why people select a drawdown rate or a cash-out strategy where they’d rather have their money elsewhere than a pension pot.
What I think happens is that we assume what we do is what others do, most of us mimic what others do , some are confident to do what we think makes sense but we do not buy a pension, (and only about one in ten buy an annuity).
We do not however complain about the state pension that comes our way set by the Treasury who determine the increase year by year and along with the DWP determine when we start drawing out pension. The WASPI issue wasn’t about the pension rate but about explanation of what was going to happen to the women’s pensions who were born in the 1950s.
My point is that we are happy to have others decide the amount the state pension is and trust Steve Webb and team when we moved to a new state pension system in 2016. We trusted the state with pensions and by and large we accept the pensions we get from our companies. The two disputes between companies and members of their DB pension plans is about the unfairness of pre 1997 pension entitlements which sometimes aren’t increased (when they could) and the non-distribution of pension surpluses (famous examples being BP and Shell though many more DB plans could choose to provide more inflation increases.
This is what I mean by “upside”. State Pensions can increase in line with retail prices, earnings increases or a guaranteed minimum – this is the triple lock and means there is upside for all with a state pension. Many DB schemes have the capacity to pay out more than the amount they promise (they aren’t allowed to use the word “guaranteed” which has been bagged by insurers).
Most of us feel our state and DB pension is part of a deal with the employer and/or the state. The annuity is a break with the relationship. Of course there is downside in having a pension which is paid from a fund created and maintained by an employer but there are opportunities to interact with the pension by becoming a trustee, reading the trustee’s acco0unt for the year and studying how things are going. Many employers want to be rid of all this and pay a premium to get the pension swapped for an annuity.
You ask what I want for my DC pension pot and for my DB pension which I get from a very good former employer. The answer is simple- I want a pension and not an annuity and I don’t want confusion with the phrase “pension annuity” which is being promoted to me by my personal pension plan provider – L&G.
I hope this makes it clear why I want to make it possible for me and others to join a pension plan with a degree of upside (one-off distributions) and very limited downside for pensioners (the Pension Protection Fund). We aren’t there yet but that is 2025’s job, the job of the Pension SuperHaven pension fund.
I don’t know, but I think there are – many others like me. I’m hoping that we can return pension savings to pension payments.
While L&G may wish to conflate “pensions” and “annuities”, others maintain the differences.
This, for instance, is Santander’s take:
There are three main differences between a pension plan and a retirement annuity
(surrender values, returns and tax treatment).
The overriding difference lies in the nature of each product: a pension plan is a saving and investment product, while a retirement annuity is an insurance contract.
I agree- from a technical point of view George. I don’t think that people buy on surrender values, returns and tax treatment. I do think that people prefer an investment driven product (with a promise of a certainty as a minimum (pension) and a guarantee from an insurer. It’s a matter of trust and the trustworthiness of pensions crashed prior to the launch of Pension Protection Fund.
I’d like to think that people have good reason to believe that when the pension is in payment, those getting a pension have equal certainty. I am such a person, I suspect you are. We wish the fund that backs our pension up grows more than expected and that it profits the sponsor, DC savers or even ourselves by way of Christmas present ( an extra payment).
We are really talking about the definition of “defined”!
Most people with defined benefit pension rights (those in the public sector) have no access to current or future discretionary benefits and inflation protection is capped by legislation. As was pointed out above, it is possible to purchase annuities with similar characteristics (e.g. a 3% or 5% escalating annuity)..
The real distinction is whether the pension income is being provided from a pooled fund where the death of one member releases funds to pay the pensions of the surviving members, or whether the insurance company can release those funds to pay dividends and whether those profits can be anticipated e.g. at the point of sale of the annuity. This raises fundamental issues of value for money for the individual or employer and also considerations of relative risk – is not an insurance company annuity inherently higher risk to the individual because of the distribution of profits prior to the death of an annuitant?
Where discretionary benefits are defined in the Deed of a pooled DB pension scheme, they form part of the pension promise just as much as the defined minimum escalation rates and the right to have them considered cannot be lost to the Member even on buy-out.
If a private sector employer can fund a DB pension scheme to buy-out level, the employer is able to use the “profit” to reduce its own current and future employment costs rather than fund the dividends of the insurance company. If the employer choses to use the surplus scheme assets to fund the future defined benefits of its employees, it not only increases its own distributable profits but also is able to use the investment return from the pension scheme assets to reduce the future cash contributions required to meet its defined pension promise. This does require any new legislation and reflects current accounting standards where the calculated interest on the corporate bond yield surplus is released to current year profits.
To go back to your basic point, Henry, this does reinforce your argument about converting DC pension pots to DB pension income; but we still have to consider who gets the profits- the individual, the sponsor, or the insurance company shareholder and when?
I think a lot about ownership of profits Oldie. There needs to be clarity about this. The principle of with-profits meant that profits had to be distributed fairly and they were governed by a policy document. Here I think there is an important role for trustees,l IGCs and others who provide due diligence. Ig a DB pension is available to people who have a DC pot in a DC trust or master trust, they must take some responsibility for the DB pension meeting its promise. That is ongoing ;. I think insurance companies who feel able to offer a pension as well as an annuity, have governance committees to scrutinise.
There is much good work going on here in Australia. I hope to bring more from Optimum.
I think “People like pensions but don’t like annuities.” is too technical. I think the reason people don’t “like’ annuities is FOMO. It’s not the annuity they don’t like. I have to take my pool of money that has taken a lifetime to accumulate and buy an annuity. Annuity rates fluctuate based on very short term factors. What puts people off buying an annuity is that it might be a bad time to buy it. Either because rates are low or because I might be diagnosed with a heart condition a week after buying the product. With a employer DB pension then there are two factors. Firstly – there’s no pot for me to look at. I can’t see that there’s £500k there. If I want to see a value I have to ask for a transfer value which is slow. Secondly, I have almost no choice. It will be converted to a pension at a certain date and the only choice I might have is to take it a few years earlier or possibly get a tax free lump sum. It’s easy and I am in blissful ignorance that my contributions over the years could have got me a better pension somewhere else. There are still plenty of people that suffer FOMO for DB pensions, hence ever more stringent requirements for transferring out of a DB pension to the point where that is almost impossible.
The triple lock for the state pension is a red herring – it has only been in place since 2011 and there’s a good chance it’ll be phased out at some point soon. So once an annuity has been bought, with some inflation protection, there’s almost no discernible difference to the average Joe from a DB or state pension.
As far as the PSH is concerned, my very limited understanding is that this is somehow investments backed. As such it can remove one FOMO factor – timing. With a long term outlook I should be able to buy the same level of income this year as someone else could in 5 years time, for the same cost. That is, the level of pension purchased should be based on long term average investment returns not on current gilt rates.
If PSH is my “default pension” from my employer, it’s still only a default and I still have a pot of money that presumably I can see – as opposed to a DB pension where there is no “pot” with a real world value that I could get hold of. I suspect many people are going to look at that and think the same as with an annuity – if I wait a while I’ll get a better rate, maybe I’d be better transferring and drawing down myself, maybe I’ll do nothing for now…
Thanks Peter, very thoughtful and thought provoking. I think people have a fear of missing out and your comment feels like it comes from working with people having to take decisions without total confidence they are doing the right thing.
Of course, a DB pension doesn’t demand a lot of decision making . If you are exchanging a DC pot for a DB pension – rather than an annuity, then the quote for you will with PSH be based on an estimate of how long you (and perhaps your spouse) will survive and the offer will be attractive if it’s considered likely to pay more. I would argue that a pension in payment offers a very similar level of certainty than an annuity.
This is a very important area of decision making, you take it seriously and comment so. Pensions have been the way most people create private retirement and continue to dominate large parts of post retirement benefits.
It is time we opened up these questions and ask why people who save into pension plans, get offered annuities, drawdown and cash out – but not a pension!
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