The paper advanced the argument that because guaranteed annuities are so low and for many they represent little more than the return of the original capital, those with above-average-sized pension funds should question whether the traditional annuity should continue to be their default option. I also pointed out a number of paradoxes in the annuity market, not least that most people make decisions about their long-term income based on short-term factors such as starting income.
In the longer term all pensioners are faced with a number of unknowns: they do not know how long they will live, what will happen to inflation, interest rates and equity markets, or how healthy they will be. The point is, a guaranteed annuity might meet a pensioner’s needs today, but it is not flexible and cannot be altered if circumstances change.
The annuity risk paradox suggests that many people think they are eliminating risk with a traditional level annuity, but in reality they are still exposed to a number of risks.
My conclusion is that those with above-average pension funds should consider investment-linked annuities or drawdown, but this begs the question – what can those with below-average pension funds do if they think guaranteed annuities are poor value?
All pensioners are equal but some have more choice than others due to the size of their pension pots. Therefore it is necessary to look at the options for those with different-sized pension pots, assuming the average pension fund at retirement is valued at only £30,000.
The options for those with below-average-sized pension pots are limited.
Although this group accounts for the largest number of private pension policyholders, they have the least realistic choice and arguably get the worst deals.
Table 1 shows the options for those with below-average pension funds who have reached retirement age.
| Advantage | Disadvantage | Comment | |
| Take tax-free cash and purchase an annuity now | Secures income now and avoids the risk of getting an even lower income in the future | Rates are at an all-time low and may increase in the future but probably not for several years if at all | Unless there are special circumstancestaking a pension now may be the best option for those with small funds |
| Defer taking TFC and annuity purchase | Possibility of higher TFC and annuity in future | You will only benefit from this if both the value of pension fund and annuity rates increase | In the past, those who have deferred purchasing annuities have rarely been better off |
| Take TFC now and purchase an annuity later | Releases cash sum now ans defers decision on annuity purchase | Rates may not improve and there will be costs involved with this option as it involves pesnion drawdown | Pension drawdown is not usually recommended for those with small funds unless there are special circumstances |
| Invest in a flexible annuity | Potential for income growth and option to convert to guaranteed annuity in the future | The level of future income may be more or less depending on investment growth | Any annuity that is not guaranteed is risky and should only be considered if the three goldern rules are noted |
Golden rules
Generally speaking, any annuity other than a traditional annuity should not be arranged and, in addition to the established rules governing advice, I have developed three additional rules:
■ Investors should have other sources of income or capital to fall back on if the future income from an investment-linked option falls in value;
■ All the relevant risks must have been explained and the client must understand them;
■ All the relevant options must have been considered.
The point about having other sources of income or capital is something I have been talking about for nearly 20 years and shows that although capacity for loss may have recently gained prominence, it has been at the heart of my annuity advice for a long time.
