According to a business associate of mine (and someone considering his own retirement options) “the sands have shifted since the pensions freedoms were announced”. Now they are here, he believes most rational people will work out the cash option is not that attractive considering the tax implications and the problem of where to reinvest it. Meanwhile, drawdown looks risky because the stock market is near an all-time high. He went further to say he thought annuities would come back into fashion – because where else can you get an income guarantee for life? However, he wished annuity rates would increase.
His final conclusion was that someone like him (Mr Middle England) should have some of his pension in drawdown and some in an annuity.
I have been arguing for as long as I can remember that most people need a combination of certainty and flexibility, which translates into a mix of annuities and drawdown.
In my latest paper “The Case for Annuities” I have addressed many of the criticisms levelled against them. The main points include:
- In the future, annuities will be used in a more sophisticated way to provide guaranteed income.
- The alternatives may look more attractive but, in many cases, an annuity is a hard act to beat for those who are risk averse.
- Most people are faced with the choice between certainty (annuity) and flexibility (drawdown) but this does not have to be a black and white decision.
- There is an invisible force – mortality cross subsidy – that gives the annuity an advantage over drawdown, especially as people get older.
It is important to separate the benefits of annuitisation from the poor image associated with some annuity policies. I can argue the case for annuities in my unique “Motely Fool” style by, for instance, talking about the need of many older individuals for simplicity and structure in their financial affairs when they are coming to grips with their own mortality, as well as talking about the mistaken belief the same goals can be achieved by systematic withdrawals from a drawdown fund. I can also argue the case in a more technical manner and this why I devoted a section of the paper to mortality cross-subsidy and mortality drag.
While every adviser who advises on retirement income options will know about mortality drag, how many know how to calculate it and use it in a practical way? Doing so will ensure their clients are getting the best possible advice, especially when enhanced annuity rates are applicable.