There remains a strong need for annuities, albeit in a different form.
Consumers have welcomed the end of virtually compulsory annuity purchase.
There are strong behavioural factors at play, including the perception that annuities are poor value and loss aversion: retirees worrying about dying shortly after buying and losing their money to an insurance company.
However, looking closely at what savers say they need at and throughout retirement, an annuity-like product might be the best way to meet those needs, at least in part.
Seeking security
At the National Employment Savings Trust (Nest), we recently carried out research that asked which features defined contribution (DC) pension savers thought were most important when it came to a retirement arrangement. The conclusion was that security was king.
The highest rated features were providing a regular income, certainty of the level of that income and certainty their money would not run out.
The pension freedom reforms have chimed well with what pension savers want in addition to security in retirement.
They also want the freedom to change their minds about the choices they have made, to be able to pass money onto family and gain access to ad hoc lump sums.
If an annuity cannot provide that combination, the outlook is gloomy for the product.
Our evidence shows that constructing a decumulation strategy that manages longevity, inflation and market risk is likely to be extremely challenging for a large proportion of savers.
Yet some consumers expect there to be straightforward products available that will do all of this for them.
Blueprint for the future
Can the market supply the old-world security of annuities and new-world flexibility that pension savers now expect in one package?
We hope so and have developed an approach that plays to the strengths of annuities while addressing the historical objections people have to them.
Nest has designed a blueprint for a core retirement income strategy; an outline of what we believe would best meet the longer term needs of a large proportion of auto-enrolled savers.
The blueprint is designed to provide members with a sustainable income for life and comprises three building blocks:
-
an income drawdown fund;
-
a cash lump sum fund;
-
later life protected income provided by deferred annuities.
A comprehensive strategy
How would this all fit together? At, say, age 65 around 90% of the member’s pot would be allocated to an income-generating investment portfolio.
Each month from then on an income would be paid out from the income drawdown fund.
In most scenarios, we would expect this income to increase year on year in line with inflation.
The 10% of the member’s pot not allocated to the income drawdown fund would go into a cash lump sum fund and be set aside in cash-like investments to be available for members’ ad hoc needs.
If the drawdown portfolio performed particularly well, the surplus could be transferred into the cash lump sum fund for a member to spend as they wished.
From age 65 to 75, a payment would be taken from the income drawdown fund each month to put towards building up a protected income for later life.
Nest would expect this amount to be between 1.5% and 2% of the pot each year.
The payments towards later life protected income would be allocated to a different portfolio specifically for that purpose.
Before the member is 75, they could still get this money back should they change their mind.
Should they die, this money could also be passed on to their beneficiaries.
After age 75, the payments towards later life secure income would be used to purchase a deferred annuity.
At age 85 this deferred annuity would pay an income to the member for the rest of their life.
We think this arrangement would deploy annuities in a way that addresses consumers’ objections.
The one hitch is that there is not yet a UK deferred annuity market. We want to start a conversation and encourage innovation.
This does not mean decommissioning entire products but reimagining them to meet the needs of modern retirees.
Mark Fawcett is chief investment officer at the National Employment Savings Trust
Source New Model Adviser