A guaranteed pension annuity can mean taking risks, and there are pitfalls with some of the flexible annuity products on the market. So, should you opt for safety or take a risk to increase your retirement income?
American life insurance company, The Hartford, pulled out of the UK pensions and annuity market recently, and whilst you could be forgiven for missing this news, it did sent ripples through the financial world. One of their most popular products, a variable annuity, crumbled in the face of huge market volatility and poor longer term interest rates. Fears were raised about the future of this flexible style of retirement income product, which is designed for those people who want to play their chances in the investment market, but still need the important reassurance of some guaranteed annuity income.
Variable annuities are essentially something of a middle ground between the absolute security of a fixed pension annuity and the risk of an income drawdown arrangement, which is very much dependent on stockmarket movements but is very flexible. Unlike fixed annuities, the annual income that is provided by variable annuities can be increased if the invested pension fund grows well. But if the fund does rather badly, the guaranteed income will not drop.
It sounds good, but there are some pitfalls. For starters, the guaranteed fixed income you get will initially be as much as 30% lower than a traditional pension annuity, on standard annuity rates. Should the fund grow, this income will rise, but that growth will depend on wider market scenarios, and the pension fund requires much more management. Typical fees for this come to between 0.5-1.5% a year, but they can total as much as 3% annually.
There is also the cost of the guarantee (insurance policy) that assures that the fixed income element of the plan is maintained. However, the economic crisis we have witnessed put underwriters on their guard and these guarantees now cost more. When you get massive stockmarket volatility the price of the guarantee increases quite significantly, and once this price gets too high, the product just doesn’t really work.
Indeed, the combination of rising costs and the fiendish complexity of the make up of these products is causing the providers of them problems. IFAs are reluctant to promote them because they are difficult to explain, and even then, until the cost of the income guarantees fall, they remain too expensive for most people. It’s just not as simple as getting annuity quotes and looking for the best annuity rates.
However, some UK providers are still selling variable annuities, with a correctly positioned and correctly priced product still having a place in the market. It is not really a shrinking market; it’s viable and growing, especially in the current economic climate. People are searching for alternatives to falling pension annuity rates but are still looking for some security.
For those who are looking for an alternative at retirement, a with-profits fund such as the Prudential’s with-profits annuity is an option. Like a conventional pension annuity, these pay a guaranteed annual income and, like a variable annuity plan, they will pay out more if your pension fund does especially well. However, any extra payment you get will be in the form of a bonus, and these bonuses have been subject to dramatic cuts lately.
A riskier option that you might consider could be to split your pension fund between a fixed pension annuity and an unsecured pension (previously income drawdown). If you want some equity exposure you can get it through an income drawdown plan, and if you want some security you can get it through a conventional pension annuity. You can buy a bit of both, and it could be more efficient.