Industry should focus on annuitisation as a concept rather than an annuity as a product
In last month’s article, I looked at how retirement advice does not have to be black or white. There are solutions that bridge the gap between annuities and drawdown, and plenty of scope to innovate the way advice is delivered.
With annuities in particular, we need a more open-minded approach.
One way of doing this is to talk about annuitisation as a concept rather than an annuity as a product.
Economists have long been interested in the concept of annuitisation and have argued that the best way to stretch an income over a person’s lifetime is to purchase an annuity.
They talk about the annuity puzzle: why, if annuities provide the optimum income payments for someone who wants to maximise their lifetime income without taking risk, do so many favour higher risk drawdown options?
The answer to this riddle has always been twofold. First, many are reluctant to make irrevocable decisions. Second, an option that does not pay a lump sum to heirs is less attractive. We can add now add a third reason – pension freedoms.
But the grass is not always greener. As we know, drawdown may not provide the same income as an annuity and there are significant risks.
The best case for annuities I have ever come across was in a US publication called Annuitisation – it shouldn’t be a secret. It made some powerful arguments as to why people should take them more seriously:
- Many are concerned about their pension income and risk of outliving their financial asset.
- There is a strong desire to preserve one’s standard of living in the long term.
- Many older people want simplicity and structure in their financial affairs.
- They are coming to grips with their own mortality and expressing concern about the desire or ability of a surviving spouse to manage money in the event of their own death.
It went on to give many reasons why investors in the US do not take them more seriously:
- The benefits of annuitisation are not sufficiently emphasised.
- There is a desire for flexibility, control and death benefits.
- There is a mistaken belief the same goals can be achieved by a systematic withdrawal from a mutual fund (drawdown fund).
This last point is the most important. When annuity rates were much higher it was certainly a mistaken belief; with them still close to all time lows, it is easier for drawdown to re-produce annuity type income.
If rates go up and equity markets go down, however, annuities will once again become a hard act to beat.
William Burrows is retirement director at Better Retirement