Dramatic cuts in the level of income from drawdown arrangements and all-time low annuity rates have left those approaching retirement between a rock and a hard place. As both retirement options lose appeal, retirees are looking at alternative ways of securing an income in retirement.
Recent research commissioned by AllianceBernstein among groups of individuals approaching retirement, or those just retired, showed confusion about the pension income options available and an appetite for more flexible ways of providing an income. While annuities are often the first port of call, the conventional practice of buying an annuity at the point of giving up work could ultimately prove costly for millions of retirees. The most commonly bought annuity, a single-life contract, provides no protection against inflation, no safety net for dependants and no leeway to reverse the initial purchase decision.
Meanwhile, those individuals who have opted for an income drawdown arrangement are facing massive cuts (up to 50 per cent in some cases) to their retirement income due to market factors such as rising longevity, stock market volatility and falling gilt yields.
While income drawdown is often touted as a more flexible retirement option, it also remains inaccessible to the majority of retirees. The main problem is cost: fees for advice, administration, distribution and fund management are all prohibitive for those with smaller pension pots. While these fees can vary considerably among providers, AllianceBernstein says it is not uncommon for a low-cost provider to charge the equivalent of an annual management fee of 1 per cent per year, along with a fixed annual payment of £250 for provision of advice, review of income levels etc. The investment management firm says the income drawdown market is "bedevilled by high fees and high-risk investment strategies", with too much money often being drawn too early and little independent and objective oversight of the advice given.
"Most retirees face an impossible choice between an annuity they don't need and a traditional income drawdown product they can't afford. As a result, up to £10bn of pension benefits is being nudged into the wrong product each year," says David Hutchins, head of UK DC Investments at AllianceBernstein.
In search of alternatives
A big failing of the pensions industry is the obvious lack of alternative arrangements to an annuity or income drawdown arrangement. Some providers are touting fixed-term annuities with the likes of LV=, MetLife, Just Retirement, Aviva and Primetime Retirement, all offering these types of products as a viable alternative to conventional annuities.
Essentially a form of drawdown, fixed-term annuities pay an income for a specific term after which you will have a guaranteed amount to purchase an ordinary annuity at a later date. While many investors are attracted by this increased flexibility, a warning from Legal & General about the potential risk of mis-selling of fixed-term annuity products may be indicative that these products are also not all they are cut out to be. L&G's group executive director, John Pollock, was recently quoted saying that these products place quite a large bet on markets and longevity in a manner that is uncertain, placing a lot of risk on the client.
Mr Hutchins agrees and says he doesn't understand why these products are even being sold. "It's nothing more than a very expensive way of buying bonds," he says, adding that fixed-term annuities take an enormous bet on future longevity, interest rates and the market environment. "If interest rates fall and markets collapse you could end up seeing a massive fall in your income at the point that you finally need to annuitise," he says.
AllianceBernstein proposes a "Retirement Bridge" as a new alternative for those approaching retirement. Mr Hutchins describes this product, scheduled for launch at the end of the year, as providing the "benefits of drawdown at the low costs of buying a traditional annuity". The product will be a low-cost, low-risk drawdown product based on a range of age-based, income-paying funds to which retirees transfer their money at retirement. "These will provide an income for the first 10 years of retirement until you buy an annuity in your 70s. So, instead of having the short-term certainty a fixed-term annuity offers and not much value, you continue to invest in the market in the short term and manage your retirement income towards a long-term outcome, which is to purchase an annuity when you actually need it."
The proposed features of this product will include an income rate that is set and reviewed annually for its sustainability and a single pricing structure, which will allow the retiree to invest in the fund for as long or as short a period as they like with no financial panellists allowing 'breathing space' for them to decide their retirement needs.
Billy Burrows of William Burrows Annuities says he likes the concept of a retirement bridge. "If you have a small pension pot you will opt for a guaranteed annuity. If you have a big pot you can afford the complex advice of a drawdown arrangement. But what we don't have is a drawdown arrangement for the middle classes. This product looks at providing a reasonable low-cost, low-risk drawdown for people with middle-sized pension pots – typically more than £50,000 and less than £250,000." He says similar products are offered via Scottish Life's Governed Portfolios and Standard Life's MyFolio risk-graded funds.
Another option that Mr Burrows proposes is for retirees to consider a portfolio of annuities or drawdown policies to address different needs and risks. "Separate pension policies can be used to purchase different annuities - for example, you could have half in a with-profit annuity and half in drawdown. Or you could have half your pension income in a guaranteed annuity and the other half in a fixed-term annuity. It all depends on how flexible the pension scheme is and, although in theory there isn't a minimum, in practice you should look at having around £100,000 in each type of annuity."
