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Chris Gilchrist: Pension rules mean dangerous decisions could be made

Few people have yet realised that the new pension rules create a nightmare for individuals, forcing them to confront and make decisions they are ill-equipped to make and would rather avoid. The consequence is that through inertia or fear, many people will not make the decisions they need to, while many more will make decisions that turn out to be wrong for unpredictable reasons.

The cause of this slow train crash is the abolition of forced annuitisation. We know that when the concept of the annuity is put to people, they do not like it. Take-up of annuities, when they are a purely voluntary investment choice (as in the US), is minimal. We also know, thanks to the learned professors, that for many people, the annuity is (at least in theory) the best choice for a pension pot because of longevity and the uncertainty of investment returns.

So, for many people, advisers ought to recommend annuities and, if they properly take account of risk capacity, should probably recommend them more forcefully than they do. Nevertheless, if people hate annuities and do not want to buy them, you cannot criticise advisers for offering them alternatives. But given the real possibilities of fixed annuitants being bankrupted by inflation and of draw-downers being ruined by a crash, advisers have to present what many of their clients will see as a devil-or-deep-blue-sea proposition.

Even bigger problems come with the management of pension funds over the period up to a retirement whose timing is less and less likely to be at all definite.If you know you are going to buy an annuity at age 65, you should, over the preceding decade, convert your fund from equities to cash. But if you were planning to enter drawdown, there would be no need to do so. On the contrary, you would aim to manage the portfolio so that by the time drawdown started, it had the appropriate allocation for drawdown, so you would probably maintain a high equity content.

The trouble is that many people in their 50s do not know when they will want to start drawing from their pension fund, let alone in what form (annuity or drawdown) they will want to do so. However good the advice they get on this issue, the result is sure to be that a significant minority, even of those who seek advice, will take what turn out to be less than optimal decisions. Those who take decisions based on intended drawdown who later have to revise that decision due to changed circumstances may incur substantial detriment relative to the lower-risk alternative they had earlier decided against.

The risk of advisers being blamed for such poor out-comes is obviously high, yet if fear of claims against them on these issues causes advisers always to recommend lower-risk investment strategies based on annuity purchase, another set of people will certainly lose out as a result of obtaining lower returns.

Quite how this will work out in practice is hard to predict. But it is clear that many people will find it hard to make the best or even good decisions. It also presents advisers with a really tough challenge in guiding clients through decisions they enjoy as much as they would being impaled on a red-hot fork.

Chris Gilchrist is director of Churchill Investments and editor of The IRS Report


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There are 6 comments at the moment, we would love to hear your opinion too.

  1. David Trenner - Intelligent Pensions 27th September 2011 at 9:45 am

    I enjoyed this article and agree with the points raised.

    Is it too late to try to make annuities more popular?

    The 10 year guarantee was part of FA70, when people of 65 were not expected to live much more than 10 years. Now they can expect to live for 20 or even 25 years.

    If people could buy a pension with a 20 year guarantee they would be less concerned at losing their money on early death, a big objection to buying an annuity.

    What do other people think about this?

  2. More and more often, people are paralysed by choice: one of those ‘motherhood and apple-pie’ words commonly believed to be a universal good. Not so. As classic experiments in behavioural finance have shown, when people are faced with more than a very limited range of options, they are unable to make a choice.

    Take away some of the downside of making a bad choice and you make the decision that much easier; so yes, attaching a 20-year guarantee would make annuity options more attractive. The problem is, at what additional cost? We are frequently told that guarantees are expensive these days.

  3. “If people hate annuities and do not want to buy them,…”

    Dont forget the moral and religious considerations of annuities, for some they are not an option and other avenues for retirement income are needed. Partly the reason ASP exists. Its not a matter of “disliking” them!

  4. Another good article from Chris Gilchrist.
    Not thought of the idea of a 20 or 25 year guarantee, but it certainly IS worth thinking about.
    I do take “Big ears” point as I have some clients for whom not being forced to purchase an annuity certainly was a moral issue.

  5. Over recent years I have yet to complete an index linked annuity application.Even at 3% the annuity quoted is impossible to recommend and clients can see the poor value immediately. Inflation is then the final killer blow for the level annuity opted for.
    For many people the annuity option is the only one. Sadly, it’s also close to being the poorest value. A rock and a hard place to be sure.

  6. keith hanna Specialist Pensions 30th September 2011 at 10:07 am

    Interesting article from Chris.

    Annuity rates are poor, historically speaking and the recent GAD rate of 2.75% pits Drawdown not any further ahead for clients who want income.

    Annuity positives are that the investment risk is removed and there are many negs as noted previously.

    Some cients believe they are going to live forever and in the next breath die tomorrow.

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