Imagine a retiree in a labor-atory tank with a £75,000 pot, a £10,000 index-linked state pension and a mortgage-free home. If they were given the benefit of free ongoing advice from a panel of experts, would this hypothetical retiree be advised to buy a level annuity invested in 20-year gilts paying 2.65 per cent?
Obviously, it would depend on our guinea pig’s attitude to risk. But the long-term decline in annuity rates has meant that in a rising number of scenarios, the answer would be no.
As rates get worse, income drawdown by definition gets increasingly attractive for people, at least into their 70s. And Bank of England governor-designate Mark Carney is showing no signs of turning off the money supply tap, so a growing number of mass-market defined contribution retirees are finding themselves stuck between a rock and a hard place. Annuity rates are just above historic lows, yet the cost of doing drawdown properly is too high for them.
I was speaking recently with someone close to the Government’s consultation
on long-term care funding.
Accessing housing wealth through equity release is, not surprisingly, high on the agenda. But getting hold of that money is expensive under the current system, which involves costly and cumbersome legal and administrative outgoings.
Offering a streamlined approach that is given safe harbour on the basis that it is used purely for releasing equity to pay for long-term care is being talked about. This is one way of ensuring that someone releasing £30,000 of equity from their home does not lose £5,000 of it on fees.
A similar problem exists for the mass market when it comes to drawdown. We already have a new breed of execution-only annuity advisers, vetted by an employer’s pension consultant, giving annuity purchasers pretty good outcomes. Could a mass-market, low-cost drawdown product ever be included in the process without full advice but through a pre-vetted execution-only process?
It is often said the annuity market is different because it is a discrete area with fairly simple choices. But what if you are on the borderline between annuity
Buying an annuity is still a decision and carries risk. Yes, our economy may “do a Japan” but, equally, who is to say we will not see a repeat of the 25 per cent inflation of 1975 in the next 20 years?
With inflation at 2.8 per cent for the second month in a row, annuitants are investing in gilts that are currently not protecting the real-term value of their cash. A level annuity rate of 5.8 per cent for a 65-year-old with a life expectancy of 22 years not only barely pays back the original investment but, in the later years, the value of what is paid will have fallen in real terms by more than half, if the past two decades’ inflation is anything to go by.
The reason annuities are considered separately may be more down to the fact they can still be advised on through commission.
AllianceBernstein’s Retire-ment Bridge already offers an off-the-peg version of drawdown, taking on longevity risk in the investor’s 70s rather than their 60s.
Will we see other providers target this growing DC at-retirement market with some form of diversified growth fund that is tailor-made for drawdown?
John Greenwood is editor
of Corporate Adviser