Retirees should be using at least some of their pension to buy an annuity, according to a new report from the OECD.
The organisation’s report, Pensions Outlook 2016, argues that even though retirees can now use their pension savings as they wish, it still makes sense to use annuities because they pay a guaranteed income for life.
The recommendation comes as new data reveals how reliant savers across the world have become on funded pensions, such as defined contribution (DC) plans. Here the value of the pension at retirement is dependent on the amount of money paid in, and the performance of the plan’s investments.
Following the pension freedoms in 2015, savers with these plans need to work out how best to generate an income from their pot.
The report claims that the assets in funded pensions represented more than half of GDP in 10 OECD countries in the early 2000s, rising to 13 by the end of 2015. Furthermore the number of countries where the assets in funded private pensions represents more than 100% of GDP rose from four OECD countries to seven over the last 15 years.
The OECD says that while this shift towards DC plans may make sense from a policy point of view, with a clear link between contributions and pension benefits, it does increase risks for individual savers.
This is because decisions around investment strategy and managing longevity risk (the risk of living too long) need to be made by savers rather than the pension scheme.
Defined contribution pensions need “improving”
As such, the OECD says that the pensions system needs to evolve, both in terms of the products that are available and the guidance services that are offered to savers.
Pablo Antolin, principal economist and head of the private pension unit, comments: “DC pensions are becoming increasingly prominent and are here to stay. In the current environment of population ageing, low growth and low interest rates, they have useful features. However, as individuals bear more risks and responsibility for managing their retirement finances, we need to focus on improving and simplifying their design to assist them in doing so.”
He adds: “To alleviate the pressure on individuals, the OECD advocates the use of financial advice and partial annuitisation which transfers the responsibility for managing longevity risk from individuals to professionals such as insurers. Governments need to ensure they support the development and regulation of these services so people have adequate access to them. In addition, we view financial education as an essential component on retirement policies.”