Are we really a nation of risk-taking retirees? Are we all destined to be high-octane octogenarians, jumping out of planes, shark diving, and playing fast and loose with our retirement income? A cursory glance at the figures would seem to suggest so: before pension freedoms were announced in 2014, around 90% of people used to buy an annuity to provide for retirement, exchanging the money built up in their pension for a guaranteed income for life. Now, only 12% of retirees do so.
Instead of opting for an annuity, many are now taking income from their pension via drawdown. This allows them to keep their pension invested and enables them to take unlimited withdrawals, until the money runs out. The income provided is not secure, and there’s no guarantee it will last for life, which begs the question of why so many retirees have chosen to surrender security when it comes to retirement income.
Control rather than risk
There are a number of explanations for the decline in the number of people plumping for an annuity, but the thrill of taking a risk with your retirement income is unlikely to be top of the list. Given that many people lack the confidence to even dip their toe into investing in the stockmarket during their working life, it seems counter-intuitive that such a large proportion are so enthusiastic about it when it comes to investing into retirement, when the consequences of poor investment returns are far greater.
There are therefore clearly other issues in play. In fact, Hargreaves Lansdown’s research (What’s the Price of Security in Retirement) shows there is still plenty of latent demand for annuities. One issue is that discerning investors won’t buy at just any price: as the chart below shows, almost half would choose an annuity if they could get a rate of 6.5% or less, whereas almost 4 in 10 would require a rate of 8% or more.
Our research also shows that the main reason people are currently shunning annuities is a desire to stay in control of their pension savings, and this is the crux of the issue. I suspect most retirees simply want to retain the option to adapt their income to their changing lifestyle in retirement.
On average at 65 a man is expected to live until 83 and a woman to 85, and that’s just the start of it. The fact that these ages are averages means that half of these people will live longer. As a result, when a man hits the age of 83 he’s statistically likely to live to the age of 89 and when a woman gets to 85, she will on average make it to 91.
Over the course of a 26-year retirement, it’s safe to assume that your income needs will change a bit, so there’s every chance that younger retirees are using drawdown to maintain flexibility.
Are you really in control?
The desire for flexibility and control is perfectly understandable, but comes with risks. In fact, heavily depleting a pension in the early years would have precisely the opposite effect – removing your ability to control your income to adapt to changing circumstances entirely.
Many people will be well served by ensuring they have sufficient secure income from their state pension, a final salary pension or an annuity, to cover the retirement spending essentials. They can then put the rest of their pension pot into drawdown, to provide flexible access to cash for some of the retirement nice-to-haves.
For those using only drawdown, the challenge is to carefully manage their pension in order to stay in control of their retirement finances. This means not only choosing the right investments, but also a sustainable amount of income. There will be few concerns if their investments perform well and they don’t draw out too much income every year. However, there is a risk of running out of money if they withdraw too much, investments perform poorly, or they live longer than expected.
It is important to avoid being forced to sell investments if they have fallen in value, for this reason taking only the income produced by your pension investments is a great way to ensure it lasts as long as you need it.
The annuity years?
For those who manage drawdown carefully, pension freedoms mean that as retirees get older, and the attractions of simplicity and security start to hold more sway, there’s an opportunity to secure the guaranteed income that an annuity provides.
We anticipate demand for annuities will pick up again, and we estimate there will be significant growth in the market around 8 to 10 years from now – as investors’ demand increases in response to their changing circumstances.
The problem is, it may not be possible to buy a competitive annuity when they want to. The number of annuity providers has halved in the last couple of years. Ordinarily a shrinking market like this would be disastrous for consumers, as higher levels of competition typically drives better value. At the moment, the shrinking number of providers is not too much of a problem. We have seen many of the less competitive providers shut up shop, in fact we estimate only 15% of the market has actually disappeared despite the loss of half of the providers. The risk is that with so few annuities being purchased, the patience of the most competitive providers may be stretched beyond breaking point. Further provider withdrawals would mean a worse deal for retirees.
Pensioners who have retired since 2014 may not have deliberately chosen to play fast and loose with their pension income. In fact, many will have moved away from annuities because it left them in control, which felt like the more sensible choice. Unfortunately it’s only sensible if you have adopted a prudent income strategy and even then you run the risk that you may not be able to get a competitive annuity when you decide the time is right. It seems that while retirees may be seeking all the high-octane thrill of a sedate paddle at the seaside, they may have accidentally signed up for shark diving instead.
Nathan Long, Senior Pension Analyst, Hargreaves Lansdown