The pension freedoms introduced last April were widely seen as a progressive and welcome move. But they mean that most people who reach retirement now face a significant dilemma: do they buy an annuity or do they instead choose to put their pension savings in another type (or types) of investment?
According to an interesting new piece of research – one of the first detailed studies carried out into the ramifications of the reforms – the latter course of action is likely to be the best bet in most cases.
The report, Pension Pots and How to Survive Them, has been drawn up by academics at Cass Business School, which is part of City University in London.
The key message? ditch the annuity
Its key message is that most savers will be better advised to use their pensions to provide a regular income, either through a drawdown investment product or some other form of return-generating vehicle, rather than using all their cash to buy an annuity.
The main factors that the study cites in its argument against annuitisation are: Annuity rates are currently at all-time lows due largely to the fact that people are living longer than ever.
Annuity purchasers run the risk of dying early and thereby wasting much of the money they spent.
Inflation-linking annuities is expensive: this means most people end up buying level annuities which don’t increase payouts every year and which therefore can be worth very little in old age.
One of the key reasons people consider annuities – and why they were effectively mandatory in the past – is that they guarantee that pension savings will never run out. With drawdown or other types of investment, there is always the risk that, if returns fall or if people withdraw too much cash in the early years, the pot could be depleted.
Addressing the risks
For anyone who finds they are indeed running out of money, the study says, they should consider equity release if they own property.
But the best way to make the right financial decisions is by seeking expert advice upon retirement. According to the report: “Annuitising is an irrevocable step and so before making a decision people should first undertake a financial ‘health check’ if they are unsure what to do.”
It adds that, anyone who opts for drawdown should seek regular financial advice during their retirement if their circumstances or financial objectives change. With the right guidance, Cass says, investments can be managed so they last for decades if necessary.
Ultimately, though, the research appears to offer a ringing endorsement of the government’s decision to allow greater financial choice at retirement. It looks likely that over the next few years millions of people will reject annuities and – if this study is correct – end up better off as a result.
As the report’s lead author, Professor of Statistics Les Mayhew, says: “The new freedoms are exciting but they need not be especially risky. If simple rules are followed, people should benefit from the greater flexibility: it is important that your pot is invested appropriately according to your preferred level of risk and that it is also managed professionally.”
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