The great auto-enrolment experiment kicked-off last month and the Government predicts an extra 8m people will eventually be enrolled in a workplace scheme.
However, the slump in annuity rates in recent years is so severe that pension savers looking at annuity rates on offer today could conclude that saving into a pension is not just poor value but is in fact a waste of money.
Standard annuity rates have been on a downward trajectory for several years but this has accelerated recently.
According to MGM Advantage, standard annuity rates fell by 7 per cent between June and September this year. Enhanced annuity rates did not fare much better, falling by 5 per cent in the same period.
MGM Advantage distribution and marketing director Aston Goodey says: “Annuity rates are in free fall, largely driven by record low gilt yields. Annuity providers have yet to fully price in the effects of Solvency II or the EU gender directive so we are expecting further falls over the coming months unless we see a significant upward movement in gilt yields.”
Barnet Waddingham consultant Malcolm McLean says: “We must now be heading towards a tipping point where annuities barely return the capital given up over an average life expectancy and thus in the eyes of most people represent an unacceptably poor investment of their pension savings.
“At a time when millions are being enrolled in pension plans that culminate in the purchase of an annuity this sends out some very negative vibes and risks jeopardising the success of the entire auto-enrolment project.”
The latest figures from The Retirement Academy show just how poor annuity rates have got. As at 5 October, Aviva was top of the best buy tables for single annuities for both men and women. For a pension pot of £100,000, a male aged 65 taking a level annuity could get an annual income of £5,882, while a female aged 65 could get £5,637.
Ignoring all the actuarial number crunching, this works out at a return of either 5.8 per cent or 5.6 per cent a year on a lifetime’s saving.
If you look at joint life annuities, for a male aged 65 and female aged 70, a pension fund of £100,000 would generate an annual income of £4,901 on a level basis.
In comparison, according to figures from savingschampion.co.uk, the best available rate of interest from the same amount on deposit is 4.5 per cent, offered by the State Bank of India for a five year fixed rate bond.
For monthly income, a five year bond from Triodos bank is currently offering 3.75 per cent, while the best fixed rate Isa is a five year fixed rate of 3.6 per cent offered by the Halifax.
This is a difference of 1.5 to 2 per cent on level, single life annuities, depending on gender, and the best savings rate but is less than 0.5 per cent of a difference between the best rate of savings interest and the best joint annuity.
But there is one very significant difference – provided you don’t start to erode the capital, if you have £100,000 in savings there is still £100,000 in savings left when you die. And, if you decide you need a lump sum in cash at some point, as a cash saver you have full flexibility over what you do with your assets (subject to early withdrawal terms) during the course of your lifetime.
If life expectancy at age 65 is 17.8 years on average for men and 20 years for women, the £100,000 pension fund would pay around £105,875 in total for a man and £112,740 for a women. A level joint life annuity would pay £98,020 to second death.
Using an interest rate of 3.75 per cent, the fund would pay £67,500 for a man or £75,000 for a women but, crucially, would leave you with the £100,000 still in the bank.
With this in mind will the option of opting out of pensions and instead focusing on long-term investing through Isas become more attractive?
Hargreaves Lansdown head of pensions research Tom McPhail believes the argument in favour of pension saving is still sound.
McPhail says: “There is a perception that annuity rates are so unattractive that it is not worth putting money into a pension.
“I disagree. The decision to coalition took in 2010 to lift the annuity compulsion rules means you can stay in drawdown. Also, not withstanding regulatory intervention that is pushing prices down, annuities are still pretty fairly priced. They still do what they are supposed to do – provide a guaranteed income for the rest of your life – and there is nothing else that can do that.
“Falling annuity rates does undermine individuals willingness to commit money to pensions at the front end. It is up to us as an industry to extol the virtues of long-term savings, of the tax breaks on pensions and the flexibility around decumulation.”
McLean suggests more radical action may be necessary. “There may be no single easy solution to the present dilemma but in the final analysis some freeing up of the restrictions on how pension pot monies may be used may become necessary before the annuity crisis spirals completely out of control.”
Are people shopping around for the right thing?
There is growing recognition that annuities are fast becoming barely more than return of capital for many people unless they live well beyond their anticipated life expectancy.
This is not the fault of annuities themselves because they still are the only policy that guarantees an income for life no matter how long the policyholder lives; it is the fault of low investment yields.
So what can be done? First of all customers deserve a better shopping experience. Shoppers, especially Middle Britain ones, are normally a savvy bunch and recognise the value of choice and quality. It is therefore surprising that a number of so called ‘annuity supermarkets’ only stock one product on the shelves, namely a guaranteed annuity. There is little sign of the other options including investment linked annuities and fixed term Annuities.
The supermarket proponents point out they enable customers to get the highest annuity income and there is no denying this. The flaw in this approach is that it assumes that the guaranteed annuity is the right thing to be shopping for. No consideration is given to other options and the customer’s longer term objectives.
I agree that the alternatives are not suitable for those with low pension incomes but there is a large slice of Middle Britain with above average sized pensions who may be sleep walking into the wrong annuity because they are not offered choice.
Secondly the industry and government has to be more creative about developing alternative solutions. The difficult question which cannot be swept under the carpet is to what extent can or should pensioners consider taking or sharing risk with the annuity providers in return for the potential for a higher income in the future?
It seems ironic that just at the time when customers need more advice there is the fear that RDR will drive these very people towards non-advised models.
Billy Burrows is director of The Retirement Academy