Beware the great annuity swindle
Millions of baby-boomers are facing a grim retirement after getting a raw deal from their pension provider. A year after Moneywise launched its campaign on retirement income, pension providers are still not doing enough to encourage customers to shop around for the best deal.
More than 800,000 post-war babies are expected to retire this year alone. Most will use their pension fund to buy an annuity, which pays out an income for life.
But around a third of people at retirement still just accept the annuity offer from their pension provider, instead of comparing it with other annuity rates and products in the open market to find the best deal. This could boost their income by thousands of pounds.
Shopping around is even more important today because annuity rates are lower than they have ever been, so retirees need to do everything possible to maximise their income.
The FTSE index is still down on its July 2007 levels by more than 10%, while annuity incomes have fallen by nearly 25%, producing a double whammy for pensioners of crippled investment returns and rockbottom annuity rates.
Today, someone with a £100,000 pension pot would receive just £5,537 a year from an annuity – almost £450 less than if they retired a year ago.
Bob Bullivant, chief executive at Annuity Direct, says: "Buying an annuity is an irreversible purchase that will have a huge impact on the quality of your retirement.
"Many people don't understand their options, so they simply tick a box when handed their retirement pack from their pension provider. But they should really seek advice and get the best annuity for their circumstances."
For a start, it is vital to consider if you have any health or lifestyle issues that could mean you qualify for a so-called enhanced annuity, which provides a higher income simply because your life expectancy may be reduced.
These issues could include smoking, high blood pressure, diabetes or high cholesterol. If you have a more serious illness such as cancer, an enhanced annuity could double the income you receive.
How the figures stack up
Take a 65-year-old man with a pension pot of £100,000. He is offered £4,911 a year by his pension provider. If he looked in the open annuity market, he could boost this to £5,537.
But if he also declared that he had high blood pressure and high cholesterol, he would receive £5,974 a year -21% more than his original offer, according to Annuity Direct.
Yet although up to half of people at retirement could be eligible for an enhanced annuity, only 27% actually purchase one, according to the International Longevity Centre UK.
Retirees also need to ask themselves the following questions: do I want my annuity to continue paying out to my spouse after I die? Do I want my income to increase with inflation? Will my income be paid monthly or annually? And what happens if I die within a few years of buying the annuity?
The trouble is that while it is preferable to get a joint, index-linked annuity that provides for your spouse if you die first and rises with inflation, those options will drastically reduce your initial income.
For example, take the 65-year-old man with his £5,537 annuity income. This will pay the same amount every year and will stop when he dies. If his 62-year-old wife were then to continue to receive the income until she died, the initial payment would be reduced by 18% to £4,567 a year, according to Annuity Direct.
If payments were also to increase with inflation every year, that first year's payout would fall further to just £2,603 - less than half the original offer.
So while these options may prove better in the very long term, if you live that long, they are very limiting in the early years of retirement.
If you can't bear the thought of giving up so much income initially, you could always try to put aside some savings to cover you and your spouse in future.
Dr Ros Altmann, director-general of Saga, says: "Annuity rates have sunk so low that it's possible someone with an average life expectancy will actually receive less income from their annuity provider in total than they paid from their pension pot. We desperately need a money-back guarantee on annuities."
It is possible to buy an annuity that promises to pay your pension fund back to your estate, but only if you die within five or 10 years. These guarantees are not expensive, so Altmann says they are worth taking out.
Those with large pension pots, typically £100,000 or more, could consider income drawdown instead of (or alongside) an annuity. Income drawdown involves keeping your pension fund invested and drawing an annual income of up to the annuity value that fund would buy.
It's a more flexible option, as you could, say, draw a smaller sum and leave the rest invested if you're still working part-time. But there are risks involved, in that your fund could perform poorly; in addition, the amount you can draw from your fund could be reduced by the government in future.
There is also a growing range of "middle market" products such as fixed-term annuities. These mature after five or 10 years, so you can buy a new annuity more suitable for your circumstances at that time.
Billy Burrows, director of Better Retirement Group, wants to see people "mixing and matching" different types of retirement income. But at present, says Altmann: "Pensioners are facing a dire combination of poor stockmarket performance, falling annuity rates, low savings rates and inflation.
"The government's programme of printing money, known as quantitative easing, has not helped. Pensioners are being battered from all angles."
It's time for action
So what is the pensions industry doing to tackle these problems? Last year, Moneywise called on it to deliver three things: to ensure all customers shop around to get the best annuity rate; to develop more flexible pensions; and to encourage saving into ISAs as well as pensions.
The Association of British Insurers (ABI) says its members are working hard to get a better deal for customers. But experts say more needs to be done. From March 2013 all pension providers will have to ask customers about their health conditions to see if they could qualify for an enhanced annuity and tell them where they can get one, as part of the ABI's new and compulsory code of conduct.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: "The new code is not perfect but it is a step in the right direction. It will hopefully make people think more carefully about their options."
But the code stops short of forcing providers to spell out how much income the customer will receive, compared with that paid by competitors in the open market. And the huge problems of rock-bottom annuity rates and inflexible pension saving look set to continue.
Stephen Gay, director of life, savings and protection at the ABI, says: "We are committed to making it easier for consumers to shop around for the best annuity deal and making the market more transparent."
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
Association of British Insurers
Established in 1985, the ABI is the trade body for UK insurance companies. It has more than 400 member companies that provide around 90% of domestic insurance services sold in the UK. The ABI speaks out on issues of common interest and acts as an advocate for high standards of customer service in the insurance industry. The ABI is funded by the subscriptions of member companies.
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.
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).