The problem with annuities

Within the last six months we have seen an increasing disquiet over the state of the annuity market in the United Kingdom. Seemingly all elements of the media have been quick to comment about how bad the situation has become and have centred on the perceived lack of clarity regarding the options available at retirement, resulting in many people potentially being less well off than they could be. This was followed by an announcement last week that the Financial Control Authority (FCA) is to undertake its own review into the annuity market.

So what is an annuity?

It is simply a product provided by (usually) an insurance company which enables you to convert your retirement savings – your pension – into a guaranteed income for the remainder of your lifetime, or possibly longer, depending on the options you take.

What is important to remember is that the decision is normally irreversible, so once you’ve selected the annuity, you generally can’t change your mind.

What are the problems?

The FCA found that in 2012, 60% of annuities were purchased from the pension provider with whom the individual had saved. It is unlikely that this percentage has shifted significantly since and the reasons for this are difficult to establish.

Despite the fact that the option to shop around, called The Open Market Option, has been in existence for 38 years, it appears that most people simply either trust what they’re told by their existing pension provider or simply don’t know that they have a choice.

The FCA also established that up to 79% of annuitants who purchased a standard annuity could have been better off had they shopped around. If they qualified for an Enhanced Annuity (enhanced due to health or lifestyle issues) this figure jumps to 91%.

What steps will be taken?

The FCA’s investigation into the annuity market is unlikely to produce a quick fix, but the regulator will be seeking ways of providing consumers with a fair deal and in time the industry will almost certainly have to change.

What can you do now?

Many people retire every week and the potential exists for them to be short changed unless they do something about it. People don’t plan to fail but they often fail to plan, and it usually pays to seek professional advice when making any financial decision. This becomes even more important when you consider the myriad of choices available at retirement.

What are the choices?

Most people will still opt for an annuity, as it provides certainty, but alternative to purchasing an annuity you could consider Income Drawdown, where your pension pot remains invested, or Phased Retirement where your funds are split into segments and you receive the income gradually. This latter option could be very useful if you don’t want to retire completely.

Both of these options are very flexible but, particularly when considering smaller pension funds, they can be relatively complex and expensive to administer. For very small pension pots is a return of the fund in its entirety, known as Trivial Commutation.

Preparation for retirement

Your pension provider will send you a pack, usually about six months before your scheduled retirement date. This will ask you to send personal information back to them and will outline some of the facts relating to the choices you have available. This will be followed by a personalised illustration that will be sent to you about ten weeks before your retirement date. If you have more than one pension provider, you will get a similar pack from each one.

Consideration of your options

The choice available to you will be to accept the quotation given or shop around. Unbiased.co.uk have recently found that 12% of people spent an hour or less on this process, while a further 33% spent less than a week. Many people spend longer on buying a car or choosing the family holiday.

When you consider the range of options available, it becomes pretty compelling for everybody to seek advice from a professional financial adviser. These include:

  • Single Life Annuity, which pays an income for your lifetime.
  • Joint Life Annuity. This pays you an income for your lifetime plus some or all of that income to your partner or dependents after you die. The income usually continues until they die or, in the case of dependents, when they reach a specified age.
  • Escalating Annuity. The income payable rises in line with inflation.
  • Guaranteed Annuity. Pays you an income for life or a guaranteed period of up to 10 years, whichever is longer.
  • Investment Linked Annuity. This pays a variable income linked to the performance of underlying investments.
  • Enhanced Annuity. This takes account of your health, lifestyle and where you live and can result in a significantly higher income being payable.
  • A combination of some of the above.

 

The case for advice

The decisions you make relating to your pension can be as financially important as buying a house, so advice in this area can make a significant difference to the outcome. A professional financial adviser can assess your circumstances, explain your options clearly and then make recommendations that will ensure you get the best deal.

 If you think you’d benefit from a review of your financial arrangements please contact us. An initial consultation is with our compliments.

David Porter, Financial Planning Consultant

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