Pension annuities are important. The decision about which annuity to buy and what annuity rate to go for are important. That is why advisers have a distinct role to play when advising about the Open Market Option (OMO). Are consumers, including you, educated properly to respond to annuity providers letters.

Unfortunately consumers, even when properly prompted, are ignoring the annuity related Open Market Option. This only emphasises the importance of utilising the expertise and market options available to an adviser to ensure consumers are best served in retirement. Advisers now have a distinct opportunity to provide their clients with a comprehensive analysis of their situation and develop a retirement solution that best suits the clients’ requirements.

It is probably fair to say that whilst advisers should consider the OMO option with their clients, the majority of clients are unlikely to have the skills and knowledge to understand why they should consider it and whether they should invoke it. 

Is your pension annuity enough, or do you need to top that annuity up? I have made reasonable provision for my future. It therefore makes depressing reading to learn that the average cost of retirement is £413,000 and if I live to be 100 retirement costs rise to £700,000.

These these latest figures are contained in a report from the prestigious Centre for Economics and Business Research (CEBR) and are not an exaggeration.  According to the CEBR, for wealthier individuals, wanting to maintain their standard of living, retirement could cost as much as £1.55 million, while retirement costs a typical couple £413,000, and an individual living alone £326,700.

A retired couple, both over 65 will have personal tax allowances of £9,030 each, plus CGT allowances of £9,600 a year each meaning they can have ‘income’ of up to £18,630 each or £37,260 as a couple, completely tax free.  On top of this they can take an unlimited amount of gains taxed at only 18% and if they have invested in Peps and ISAs, a tidy sum in tax free income from these investments too.

For younger people starting to save for retirement today, the outlook is uncertain. You can currently invest up to £7,200 a year in an ISA and unless an employer is contributing to an occupational or group personal pension, it pays to save in the ISA rather than a pension scheme because of the greater flexibility this gives and the fact that you are not forced into buying an annuity. 

Look at an example of using Peps and ISAs compared with pension savings. Take two investors who both have £7,000 to invest. One puts it in an ISA, the other puts it in a SIPP or personal pension. If the investors are higher rate tax payers, then the £7,000 put into a pension is immediately equivalent to a grossed up contribution of £11,666.

Assuming that both invest in the same unit trust, and that the value of the investments in both the SIPP and ISA double, the value of their investments will be £23,333 in the SIPP and £14,000 in the ISA.  At retirement 25% of the pension can be taken in tax free cash, equivalent to £5,833,  but the rest taken as pension is subject to income tax at the investor’s highest rate.  Assuming 5% is drawn down from the remaining pension fund of £17,500  income after tax at 40% would be £525 a year.

Meanwhile, the ISA investor can take the full value of the fund, £14,000, tax free at any time.  But comparing it with the SIPP investment, if you withdraw 25% or £3,500, then a 5% drawdown from the remaining ISA fund of £10,500 is a tax free £525 – the same as the SIPP. 

Only 10% of advisers would look to purchase a pension annuity with the whole amount of their pension savings, according to Skandia in a recent survey. The research also found over half of advisers would use their entire pension savings to go directly into income withdrawal and not an annuity, while 38% would use a combination of income withdrawal and an annuity.

Their reluctance to embrace annuities for themselves has made advisers more likely to recommend income withdrawal to their clients, with 61% of advisers expecting income withdrawal business to increase over the next year. This is a good point to suggest that this is for larger pension pots.

Nearly a third of advisers surveyed felt income withdrawal is appropriate for over half of their clients, while a further half of advisers believe it suits over a quarter of their clients.

The research indicates advisers and consumers are becoming increasingly proactive in seeking to avoid the inflexibility of an annuity, Skandia says.

We are living longer and therefore having a greater dependency on the state pension and a pension annuity. In 1950, around 16 per cent of the UK population was aged 60 or over. By 1980, that had increased to 20 per cent and by 2030 around 25 per cent of the population will be 60 or older. Retirees and those approaching retirement and the time to buy that pension annuity need to look at the likely life expectancy of others of their own age.

Between 1981 and 2005, life expectancy in the UK as a whole increased by four years for 65-year-old men and 2.8 years for 65-year-old women. As a nation, we have greater life expectancy in retirement. 

The Pensions Policy Institute produced a pensions facts document in February, using data from a wide variety of sources. These figures tells us that, for 2005/06, the average proportion of pensioner income paid from the state, including retirement pensions, disability benefits, pensions credit, etc, was 55 per cent and this figure has remained pretty much constant since 1997/98.

According to the Office for National Statistics, already around 19 per cent of the total population is aged over state pension age and that is projected to increase to 21 per cent by 2050, even after allowing for significant increases in the SPA which come into effect before then.

All this, and other factors in addition, is the background against which a number of providers, including Met Life, Aegon, The Hartford and Lincoln have, over he last two years or so, launched so-called third- way annuities into the UK.

These contracts, under their American name of variable annuities have been hugely successful in the US and Japan. In effect, they are a form of hybrid of annuity and drawdown contracts allowing the annuitant to benefit from a guaranteed level of income while still investing in the stockmarket with the potential for growth which would increase the guaranteed income payable.

The models of third-way products are different from provider to provider as well as country to country. What they have in common is the presence of some form of “guarantee” in the form of lifetime income or availability of capital at some point in the future.

Actuarial consultancy Tillinghast Towers Perrin estimates that inflows into variable annuity products will reach £70bn by 2016. Broadly, the obvious attraction is continued exposure to the market to benefit from the potential for growth while protecting the fund/income from potential downsides.

The cost of these products has been used as a reason for not recommending them. Obviously, the charges for this type of contract will be higher than for investment vehicles which do not protect against downside risk but any form of insurance comes with a premium.

The current market volatility and, to some extent, the slowdown in the housing market combined with the credit-crunch, which make a reliance on equity release less certain, mean this is an attractive concept for today’s market. The US experience suggests that it is equally attractive in all market conditions so it may well be here to stay.

Apparently, more and more people are considering alternatives to a pension annuity. Two-thirds of IFAs say the ongoing stock market volatility has spurred their clients into changing the way they plan for their retirement, according to research by MetLife. The question still remains: is there something out there better than a guaranteed pension annuity?

According to the research, investors are increasingly asking for advice on alternatives to traditional annuities and drawdown, including pension products with unit-linked guarantees, variable annuities, with-profits annuities and impaired life annuities.

Dominic Grinstead, strategic development and marketing director at Metlife, says, ‘Stock market volatility and growing worries about inflation are raising uncertainty. So it is no surprise that pensions with unit-linked guarantees are becoming more attractive as an alternative to traditional pension products.

‘They address inflation by facilitating exposure to equities, which have an in-built defence against price rises in the long run, and protect pension pots against stock market falls.’

Trouble is, everything has an element of risk to it, and a guarantee has to be a good thing.