What new pension products could be on the horizon?
A wave of new investment products designed to provide an income in retirement could be set to hit the market, following the changes wrought by chancellor George Osborne in this year's Budget, a new report from pensions expert Dr Ros Altmann predicts.
The report, which was compiled in partnership with MetLife, exposes the current poor value in annuities, and suggests new products are needed that help guarantee income when required but offer more freedom than the typical annuity.
Under Osborne's changes, retirees will be able to access their entire pension pots when they reach retirement age, rather than being effectively forced to buy an annuity as was previously the case.
Demonstrating her point, Dr Altmann presents the example of a 65-year old couple, who have about a 50% chance of living to age 89 and a one in six chance of living to 95.
Owing to the 'sharp fall' in annuity rates over the past five years, however, around half of people this age are unlikely to benefit significantly from buying a standard annuity.
According to Dr Altmann's research, a joint-life annuity - which will keep paying as long as one member of a couple is alive - pays about £5,500 per year for £100,000 paid up-front.
If the funds were invested and earned a net return of 3.5% while paying that same income, there would still be £20,000 left over by age 89. If £6,000 were drawn each year under the same circumstances, the money would be about used up at this point.
In better market conditions where investments grow 4.5% annually, someone who took £6,000 per year from an original £100,000 pot at 65 would still have £30,000 left over when they reached age 90.
In contrast to an annuity, this sum could be passed on to next of kin or used to pay for later life care if the need arose.
Dr Altmann predicts some of the changes could be reflected in the greater use of existing but currently less mainstream annuity products.
Individual underwriting: people with poor health may be able to take more income from an enhanced annuity. Some annuities already differentiate between different geographical areas, and we could see more individualisation, for instance by work history or other lifestyle factors.
Money-back annuities: these promise to repay any remaining unused capital if someone dies before having received that amount. These already exist but are made less appealing because of current harsh tax treatment.
Later-age annuities: if people wait until they are older to lock into an annuity, their needs in later life could be better reflected in the income they receive. Moreover, because the annuity will have to last for a shorter length of time it will not be as exposed to the eroding effects of inflation.
Investment-linked annuities: some existing annuity products offer benefits from future returns or guarantees that income will not fall below a certain level, but they are not hugely popular. These may come to occupy a more prominent space in the annuity market, Dr Altmann suggests.
The report also outlines several innovative annuity products that could help address peoples' changing needs:
Non-linear income annuities: these could offer a 'u-shaped' or 'j-shaped' income to accommodate the times when retirees tend to spend more money, namely early in retirement and later when they need care.
Annuities with surrender value: an annuity that gives a certain amount of flexibility if circumstances change and income needs to be adjusted. Similar to insurance products, these might be more expensive but will offer protection from unforeseen developments.
Advanced life deferred annuities: an annuity that will only start paying out from a much later age, for example 80 or 90. This allows a retiree to live in the knowledge they will have a secure income if they live a long time.
Care funding annuities: a type of deferred annuity that pays a much higher income if care is required.
Annuities with life insurance: an annuity that comes with some sort of term assurance that will pay a lump sum if the retiree dies relatively young. This means their kin could still benefit from the value of the retiree's pension pot where a typical annuity would cease paying out.
Non-annuity products could also rise to meet the opportunities presented by the new pension environment:
Lifetime pension accounts: functioning as both growth and income funds, a single pension could initially focus on reinvesting returns to grow capital, and switch to a focus on paying an income when the saver decides to retire.
Pension growth roll-up funds: instead of 'lifestyling', whereby one's investments are moved towards bonds in later years, these funds could focus on capital growth by initially investing in illiquid assets and gradually moving to more liquid options as retirement age approaches and the need for income increases.
Multi-asset growth funds with volatility options: funds with a variety of risk levels and growth projections, rather than the traditional single number.
Diversified growth funds: essentially diversified growth funds that could include illiquid assets such as property, forestry or infrastructure, but could also offer an income element in retirement.
Pension income funds: these could provide income from a combination of investment returns and capital, attempting to 'smooth' payments over time.
Unit-linked guaranteed funds: these could offer income as well as investment growth, while protecting from a downturn in markets. Guarantees cost money so these might be more expensive options, whereby the customer pays a premium for greater peace of mind.
20-year retirement bonds with provision for care funding or longevity: these could help alleviate the uncertainty of drawdown income if someone lives much longer than expected. They could be combined with a deferred annuity which begins paying out after 20 years to offer a seamless income in later life.
Deferred annuities: these could be purchased with part of one's retirement pot, and would begin paying after a set amount of time - for example 10 or 20 years. The product could provide a relatively higher income or a single capital sum at that later date.
This article was written for our sister website Money Observer
The amount of cash a policyholder receives from the life insurance company if they surrender (terminate) a life insurance policy before it becomes payable on death or maturity. Surrendering an investment-linked life assurance policy early is likely to be a poor deal as most policies load the majority of the policy’s fees and charges in the early years and so surrendering the policy back to the life company will result in a very low payout.
Term assurance provides cover for a fixed term with the sum assured payable only on death. Term assurance premiums are based primarily on the age and health of the life assured, the sum assured and the policy term. The older the life assured or the longer the policy term, the higher the premium will generally be. There are generally two types of term assurance. Level term assurance premiums are fixed for the duration of the insurance term and a payment will only be made if a death occurs during the insurance period and with decreasing term assurance, life cover decreases during the insurance term reducing the cash payout the longer the term runs and this is reflected in the premium.
A feature of defined contribution pension funds. As people move closer to retirement, their tolerance to risk reduces. “Lifestyling” recognises this and provides an automatic switching facility from funds with higher volatility to ones with less volatility as retirement approaches. Generally this means the pension fund manager gradually moving a client from riskier assets such as shares into corporate bonds, gilts and cash as they near retirement.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Generally thought of as being interchangeable with insurance but isn’t. Assurance is cover for events that WILL happen but at an unspecified point in the future (such as retirement and death) and insurance covers events that MAY happen (such as fire, theft and accidents). Therefore you buy life assurance (you will die, but don’t know when) and car insurance (you may have an accident). Assurance policies are for a fixed term, with a fixed payout, and unlike life insurance have an investment aspect: as a life assurance policy increases in value, the bonuses attached to it build up. If you die during the fixed term, the policy pays out the sum assured. However, if you survive to the end of the policy, you then get the annual bonuses plus a terminal bonus.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).