In my view, the critical difference between annuities and drawdown is the impact that annuitisation has on the trade-off between income and death benefits. Higher death benefits result in lower income and vice versa. You cannot magic something out of nothing or magic the risk away.
It is interesting to note that drawdown has a similar market share, at around a quarter of the market by value, as in 2001. If we look at the number of cases sold in 2007, I have to point out that the motion looks even more far-fetched. Less than 10 per cent of the half-million annuity and drawdown cases ended up in drawdown. Perhaps as many as half of these are taking drawdown to release tax-free cash while taking no immediate income.
There is a long way to go before annuities are replaced by drawdown. One major reason is the size of pension funds. Over three-quarters are less than £30,000 after tax-free cash has been taken. Fund sizes are such that most people do not have scope for drawdown.
Perhaps those supporting the motion see a way of charging the extra costs needed for ongoing advice and extra administration in a way that is acceptable and gives value to consumers and complies with treating customers fairly?
Too many people, including many of Billy’s middle England, are not saving enough for their retirement. A lot of people are going to need a retirement income product that maximises their income in a cost-effective and low-risk way, in other words, an annuity.
It is not a question of if but when pensioners should fully annuitise, remembering that this is not necessarily when the annuity is first purchased.
Pensioners need a retirement annuity account which limits the fund at risk in the early years but retains mortality cross-subsidy in later years to provide the essential longevity insurance. This can be achieved by providing some death benefit in the early years of an annuity when the impact of the cross-subsidy is small while ensuring that by the time annuitants are into their 80s, their fund is annuitised and receiving the benefit of the mortality cross-subsidy.
Billy and many commentators suggest that the charging structures used by variable annuities are superior to annuitisation. Any scheme designed to pay guaranteed income to those who live beyond their life expectancy requires some form of cross-subsidy.
US-style variable annuities provide a minimum lifetime guarantee as an alternative to a lifetime annuity but are not a panacea for all. They provide higher death benefits but this comes at the expense of a lower income than available under an annuity, particularly if the same investments are held.
Let us look at the two charging options for securing a guaranteed lifetime income. The annuity charging approach relies on a cross-subsidy between those living longer and those dying earlier. Those dying earlier lose out significantly. The approach achieves the highest lifetime guaranteed income because there is no residual fund at date of death.
Under the variable annuity charging approach, extra fund charges are made for guarantees. The result is that those dying early provide only a modest cross-subsidy. This gives high initial death benefits. However, the associated Tom Boardman, group policy development director, Prudentiallower cross-subsidy from those dying early results in a lower guaranteed lifetime income.
If you surrender your contract or want to take income above the guaranteed level or move into a lifetime annuity, the value of the charges paid to date is likely to be lost.
This approach is best for asset-wealthy pensioners who need a modest percentage guaranteed income throughout retirement and are looking to preserve a death benefit.
A move to providing higher guaranteed incomes closer to the levels provided by annuities will require high charges which will exhaust the fund faster and reduce death benefits.
Pensioners using drawdown risk outliving their capital or having to reduce their income as they get older. If lump-sum death benefits are allowed, they could end up leaving more or less than they want to, depending on when they die. They also take on significant investment risks, in particular, that their investments underperform. Drawing down income when markets are depressed can have a significant impact on overall income levels. They are also exposed to the spot risk should they decide to annuitise.
Only those who can afford to take these risks should do so. Given the lack of adequate pension savings, this is unlikely to be a majority, let alone the dominant majority to support the motion.