Choosing what your clients should do with their life savings and when they should do it is one of the most critical decisions you can make as a financial adviser. Annuitising is a once-in-a-lifetime decision and it is crucial to get the timing and the product spot on.
There is an increasing range of post-retirement options available for customers, with the recent emergence of several so-called third way products from firms such as Met Life, Lincoln Financial and Living Time. These are designed to give clients the safety of a guaranteed income with the flexibility and potential for investment growth of drawdown. They also allow clients to delay the point at which they have to lock into an annuity.
Despite these new options, the vast majority of savers still opt for annuities when they retire although drawdown is becoming more popular in various forms.
With alternatively secured pensions effectively killed off as a viable alternative to forced annuitisation at aged 75, the question is when, and not if, customers annuitise.
According to annuity specialists such as William Burrows Annuities director Billy Burrows and Annuity Direct’s Stuart Bayliss, more people are taking their pension in stages. This has been largely facilitated by A-Day changes, which allowed people to take their tax-free cash without investing their pension.
But it is also tied to the fact that people are living longer and have different stages of retirement – with more people going into partial retirement and working way beyond state retirement age.
Many of these customers are opting to take their tax-free cash to supplement their income and wait to invest the remainder of their pension pot.
Burrows, however, is adamant that the optimum time for buying an annuity is when someone retires – between 60 and 65. But he concedes that there are several reasons for delaying the decision.
One obvious reason is if they are well off and do not need the income. Another is if customers feel annuity rates are low and might increase. This, says Burrows, is particularly dangerous.
“If someone has a £100,000 pot and can get an income of £6,000 a year – if they delay buying an annuity for a year their fund will have to do extremely well to make up for that £6k they missed out on,” he says.
Bayliss also points out that a customer’s state of health should be a key part of the decision-making process. A male smoker, for example, will receive a 25 per cent uplift on his annuity rates if he opted for an impaired annuity. He is unlikely to trump this by leaving his pension in the stockmarket for another couple of years.
Too often, people focus on predicting annuity rates and ignore what will happen to the value of their pension fund, says Burrow. After all, it is no good if the annuity rate increases and the value of the pensions fund decreases over the same period.
Syndaxi Financial Planning managing director Robert Reid agrees with this sentiment, arguing that customers that effectively bet on annuity rates going up are likely to find themselves out of pocket.
“No one should second guess the annuity market,” he says.
One of the reasons for this, of course, is increasing life expectancy. As life expectancy increases, annuity rates will decrease. So delaying annuitisation could leave you with worse rates and minus a couple of years’ annuity payments.
Reid points out that insurers, not customers, are bearing the brunt for miscalculating life expectancy. This is because actuaries are underestimating how long people live – leading to inflated annuity rates. “This actually makes annuities a very appealing buy at the moment,” argues Reid – contrary to popular opinion.
Trying to work out when the best ti me is to annuitise can be a minefield, says Bayliss. Those that put off buying an annuity four years ago and purchased one today would have been laughing their way to the bank. They would have benefited from improved investment performance, stable interest rates and the fact that insurers had failed to update their annuity rates to accommodate increased life expectancy during the past few years.
If, on the other hand, a client has delayed annuitising for the past 10 years, their decision would have clearly backfired.
“So, the man with a crystal ball would have done very well,” says Bayliss.
But having said this, Bayliss argues that with specialist advice it is possible for clients to get a good idea of whether they are likely to benefit from delaying annuitisation.
For example, any client thinking of delaying buying an annuity at the moment should probably think again. This is because annuity rates are unlikely to improve on their current level for the foreseeable future – with updated life expectancy calculations introduced next year and the credit crunch keeping interest rates in check.
While agreeing that annuity rates are on the decline in the longer term, Hargreaves Lansdown head of pensions research Tom McPhail believes it makes sense for those that can afford to take on investment risk to delay annuity purchase until at least one’s early to mid-70s.
He says: “The change in life expectancy, and in particular the mortality profile, now means there is relatively little benefit to annuitising in one’s 60s. There is very little mortality cross-subsidy built into the pricing. The older one gets, the more attractive the security of an annuity becomes.”
McPhail argues rather than trying to second guess life expectancy, it may be better for a client to hedge their bets by splitting their fund and buying more than one type of retirement income – annuity and income drawdown, for example.
Opinion as to who can afford to even entertain the possibility of drawdown with some or all of their pot varies from clients with £50,000 to those with £250,000. But Burrows, Reid and Bayliss are all agreed that more and more people are opting for a combination of different products – dividing their pot between drawdown products with level annuities and inflation linked annuities.
Back to the specific question of when most people should annuitise, opinion clearly varies. But there is broad agreement that people should not automatically annuitise when they retire and should consider more flexible options to accommodate the fact they are living and working longer.
It seems the pensions market is slowly waking up to this idea but it remains to be seen whether these third way products fit the bill.