The Organisation for Economic Cooperation and Development has just published its 2016 Pensions Outlook and it is essential reading. There are several things that jump out of the pages. The first is the importance of financial advice and the need to fill the advice gap and second is the importance of annuities.
The report says that policy makers need to ensure that people receive retirement advice that is appropriate for their needs and they need to make sure that advice is accessible and to those with moderate financial wealth because there is an advice gap in the UK.
The report also talks about the importance of annuities and partial annuitisation and warns about the possible detrimental effects of the decline in annuities in the UK following pension freedoms.
My first reaction is that this is all very obvious to those who operate at the coal face of pensions so why is there such a disjoint between the so-called experts and policy makers?
We can’t just blame policy makers for the mess we are in because there are other forces at work not least the move towards ‘populism’. In short, the public has increasingly become sceptical and untrusting of the so-called experts so that have looked elsewhere for their information and advice.
I totally agree with the sentiment behind pension freedoms and have been consistent in calling for the end of compulsory annuitisation, but I disagree with the direction of travel for retirement income solutions. In short many people are discounting the benefit of guarantees and long term solutions in preference for short term monetary gain. Why consider a sustainable lifetime income when you can take your cash when you want?
Behavioural biases and technical troubles
So how can we get ourselves out of the mess created by a such a wide advice gap? Perhaps the answers can be found in bridging the gap between the behavioural and technical side of the equation.
On the behavioural side, many people have a long list of misconceptions; advice is complex and expensive, annuities are lousy but drawdown is better, cash in hand is better than long term income. On the technical side, sequence of returns risk is not theoretical but a real risk that can seriously damage a drawdown plan, the mortality cross subsidy in annuities is very small at younger ages but increase with age and inflation erodes the spending power of a fixed income.
The problem for many people is that the behavioural factors are given more importance than the technical factors because they trust their own instincts and they don’t understand the technicalities. A good adviser will not only nudge and challenge some of the behavioural misconceptions but will explain the complex issues and recommend the solution that will produce the best outcome.
In conclusion, what is needed is not yet another report telling us what we already know but some practical actions that will close the advice gap and result in better outcomes which may include partial annuitisation.
Annuities are my specialist subject and I have argued for over 25 years that most people will benefit from purchasing annuities as they get older because not only do they provide guaranteed income, they help reduce the overall risk of a drawdown plan. However, I have also argued that decisions about annuities need to be considered in the context of value for money. It is an uncomfortable truth, but even though there is a strong behavioural reason for purchasing annuities, there are many technical reasons why now is not the best time to purchase annuities because interest rates are so low.
Bond yields may increase next year as a result of post Brexit inflationary pressures and the equity markets may come off the boil so this will strengthen the case for partial annuitisation.
Billy Burrows is director at Retirement Intelligence