Feature article on annuities for Corporate Adviser magazine
by Dr. Ros Altmann
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Annuities are a ‘special case’ in the financial products arena. Government forces most people to buy an annuity with their accumulated pension savings and once bought, it can never be changed. Yet Government does not ensure that people buy the right annuity for their own circumstances, at a competitive rate.
Annuities are complicated, so people need help to understand them. However, it is generally only those with large capital sums who actually get any advice. Almost all other annuitants are left to make this daunting decision on their own. Members of company schemes often end up just taking the annuity of their pension provider, rather than trying to secure the best annuity for their circumstances at a top rate.
In theory, everyone can take an ‘open market option’, and ‘shop around’ for a better annuity than the one offered by whichever company managed their pension savings. In practice, however, this entails filling in so many forms, that people are put off. Without anyone to help them decide what to do, it is much easier not to take the open market option, since all this requires is ticking the box on the form provided by the pension company and sending it back. The result is that people often end up with the wrong type of annuity, or get a poor rate, or both. The difference between best and worst annuity rates can be 20%, and even more for those in poor health. Indeed, form many people, the extra income they can receive from shopping around for the right annuity can be more important than the investment products they chose. Yet most people do not have a clue how to buy an annuity.
I think it is vital that Government ensures everyone considers, with an adviser, the few basic questions they need to think about before buying their annuity.
- Could they qualify for enhanced rates?
- Should they cover their spouse?
- What about inflation-protection?
- What guarantee period?
As defined contribution pensions spread widely, if mandatory annuitisation remains, urgent action is required. Ensuring retirees consider the vital questions before purchasing their annuity, could make many pensioners, typically those with moderate capital sums, better off for the rest of their lives. At no cost to Government.
Should employers be persuaded to offer such an annuity advice service to their workforce? I wonder whether corporate IFAs have considered approaching companies for whom they have set up pension schemes and suggesting to them that each member who comes up for retirement should be given an advice session as an employee benefit. This could perhaps be a free service on a company intranet, or a one-hour advice session to go through the basic questions that could make the difference between employees buying the right annuity or being stuck with the wrong one for the rest of their life.
Annuity advice should not take too long and charges could be levied on a fee basis, with perhaps a minimum of £100. The key point here is that the cost of advice is already potentially included in the product – up to 1.4% is currently deducted on annuity purchase anyway, whether an adviser is used or not. Even a £20,000 capital sum, could provide over £280 to cover an adviser’s fee.
Annuity help could ultimately be delivered by specialist annuity advisers, but this is not possible at the moment. The FSA would need to approve a particular type of advice for annuity purchase, without the normal 6-hour full fact find, but just answering the few vital questions. If the person’s circumstances are simple, this should be enough to select the right annuity. If their circumstances are more complex, they would need more advice.
This would help cut costs, but there is plenty that advisers can do immediately.
With help, the retiree would have someone to assist them understand the important issues when finding the right type of annuity and then find the best rates (choosing from one of the top 5 perhaps). To an adviser, this exercise would be easy. For each individual, it is often impossible. The FSA produces useful annuity information and decision trees can make any advice process easier, quicker and cheaper, but decision trees and leaflets are not enough. People need someone to talk through the relevant points, before making this irreversible decision.
If Government were to legislate that anyone buying an annuity must first have signed a form to confirm that they have discussed the relevant issues with an adviser before buying, or sign that they have refused to do so, then the open market option would become more of a reality. At the moment, for far too many people, it is not a practical option. As defined contribution pensions become the norm, ensuring people get help before buying their annuity will become ever more important. This is a challenge and an opportunity for financial advisers.