PensionsJan 22 2015

Pensions spotlight: Future of annuities

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Pensions spotlight: Future of annuities

Is this the future of the annuities market? It is certainly one possibility envisaged by pensions minister Steve Webb when he mooted the suggestion that annuitants should be given the option to sell their annuity and so join the brave new world of pensions freedom due to start in April. Currently, of course, this is not possible – an annuity purchase is a once-in-a-lifetime, irreversible decision (unless it was made after Mr Webb’s new regime was announced last year). With approximately 6 million annuitants in the UK, a second-hand market could be enormous. But would it offer buyers or sellers a good deal, and would it take off?

As with most issues concerning ‘freedom and choice’ – the government’s catchphrase for its pension reforms – opinion is divided. The split is a clean one between the pensions industry – espousing the view ‘they don’t know what they’re doing’ – and consumer groups, putting forward the ‘let us decide what is best for us’ argument. This split holds across almost all areas of pension reform but is particularly pronounced on the matter of the second-hand annuity market.

The pensions industry is concerned that with free choice comes the potential for extremely bad decisions. The UK’s reform plans come at a time when more liberal pensions markets – such as those in the US and Australia where hardly anyone buys an annuity – want to boost their annuity markets and so reduce the number of pensioners who run out of money.

Model world

Ironically they have been looking to the UK as a better model – and many local experts are aghast at the thought that the UK wants to copy their model. In Australia, for instance, there is a ‘road trip’ culture. When they retire, pensioners cash in their savings, sell their house, buy motor homes and travel around the country in one big blow-out adventure. It sounds great.

But then they run out of money in their late 70s or 80s and fall back on state support, which isn’t so great. If only there was a guaranteed pension for life that they could buy instead? Like an annuity; less fun, but more sensible.

The second-hand annuity is yet another step towards the Australian model direction. Experts fear that millions of annuitants will be tempted to cash in their £10,000 a year or less annuity. While the lump sum might look massive, actually it would be bought at heavily discounted prices giving the consumer a really bad deal.

As with any financial market, there is always a cost of trading and few pensioners would be better off as a result. Worse still, it would be difficult to know what really is a good deal due to the complex pricing systems used.

The most vulnerable members of society would be left exposed to unscrupulous financial companies, leaving them impoverished and reliant on meagre government hand-outs in their final years (insert a Daily Mail headline of your choosing here.) In short, people don’t know what they are doing, particularly when it comes to complex financial stuff, and it is all going to end in tears.

Consumer groups, however, are largely sick of being told by pension experts that they know best. And given that the City as a whole has not covered itself in moral glory in recent years, distrust is running high.

Cashing in a perfectly good £10,000 annuity for a lump sum that is less than what it is really worth may look a bad deal on paper. But what good are small annuities?

If people want to go on a cruise, or roam around Europe in an RV, instead of sitting at home counting the pennies, why shouldn’t they? Most people understand the risk of running out of money. But for many annuitants with modest incomes, the risk of this is outweighed by the opportunity to enjoy themselves while their health lasts.

Enhance your life

There will also be many whose annuity does not represent good value due to health issues or other circumstances. They may well be better off simply selling their conventional annuity and buying an enhanced one, or a different type of annuity altogether. In short, it’s our life, we are all different, let us make the decision for better or worse.

Both sides of the argument have their merits. But the pensions industry is fighting a losing battle. Experts have warned, and will continue to warn, of a savings time bomb in the UK, that future generations are going to find themselves out of cash and out of luck in their golden years. That may be so. But it is amazing how good people are at making their own decisions – and living by them – when presented with the facts and a set of options they can understand.

From now on, the job of supporting not only new retirees but all pensioners, even those with annuities, will fall on the shoulders of the government – through its free guidance service – and financial advisers. It is a massive task and nothing short of a social revolution. The boost to the economy over the next few years from pensioners spending their money could be enormous. And the opportunity for financial advisers and other service providers is unprecedented.

Devil of the detail

There are plenty of devils in the details. How will a second-hand annuity market be regulated? Will annuities get sold back to their original providers or transferred? How will the paperwork be managed? Will people really be prepared to pay for advice, or just take the free one and then Google providers and websites like they do for car insurance?

But the fact is that the more complex the issues, the more help people need. It may well be that over the next decade, personal financial planners will become as commonly consulted, and trusted, as GPs. So that whatever shape the annuity market takes – whether it is Sotheby’s-style or Walthamstow Market-style – millions of consumers will need professional advice.

Bob Campion is head of institutional business at Charles Stanley Pan Asset Capital Management