New research has indicated that 1.1m people face inadequate incomes even if they choose to annuitise, a figure that could rise to 1.4m if all those with defined contribution pensions blow their pots.
The report published by the International Longevity Centre-UK and sponsored by Aviva, models the outcomes of four different approaches to using DC pension wealth: annuitising, blowing the pot on big ticket items, putting everything into a savings account and leaving the fund invested.
It uses data from the English Longitudinal Study of Ageing, applying the methodology to different consumer segments aged 55-74.
Leaving the fund invested risks people running out of money before death, as well as exposing individuals to substantial income volatility. Within a balanced fund of 60 per cent bonds and 40 per cent equities, ILC-UK estimated that average annual income in retirement could range between £18,000 and £12,000 until the fund runs out.
The report also identified 850,000 individuals who are at high risk of seeing big income shortfalls from making particular decisions, mostly because they have low levels of financial capability allied to a high concentration of financial wealth locked up in DC schemes.
For this group the report found that blowing the pot would lead to a substantial fall in average projected replacement rates – from almost 70 per cent if they annuitise, to less than 40 per cent if they blow the pot.
Putting everything into a savings account could also result in substantial income falls at the end of life – from a replacement rate of over 60 per cent when they have some savings to less than 40 per cent when savings run out.
In response, the report argues that annuities must play a “key role in any future default strategy” given their benefits for those who will be highly reliant on their DC pots for retirement income.
However, the authors argued that consumers must be appropriately forewarned that they will be auto-enrolled into the product and enrolment must not occur until the individual reaches state pension age.
Given that people typically underestimate their life expectancy by upwards of four years, spending savings too early is a real possibility, according to the study.
Ben Franklin, ILC-UK senior research fellow, said: “Annuities are generally misunderstood and the group who stand to lose the most from spending everything too early, also score relatively poorly on financial capability, making them particularly susceptible to poor decision making.
“Without the appropriate support including a new default strategy, these individuals could end up significantly worse-off in retirement”.
John Lawson, head of policy at Aviva, added: “We know people frequently underestimate their life expectancy and this research underlines how crucial it is to consider all your potential financial needs across the whole of your retirement, not just in the short term.”
peter.walker@ft.com
