Homer – the Greek lyrical poet, not the dad in The Simpsons – was the first to immortalise the struggle to resist temptation when he wrote about Odysseus having to be tied to the mast of a ship in order to resist the songs of the Sirens.
He did not of course know about pension freedoms, but it highlights a key challenge in explaining the ability to defer gratification to earn rewards with which the retirement income market will have to grapple.
Academics have put the concept into practice: last year researchers in Sweden conducted a study among 13,000 13-year-olds who were offered the choice of the equivalent of US$140 now or US$1,400 in five years’ time. Reassuringly the better-educated 80 per cent were willing to wait, but one in five still chose instant gratification.
Florida lottery winners illustrate the pension freedoms dilemma perfectly – Powerball, Lotto and Mega Money winners are offered the choice of a lump sum or an annual payment. Between December 2009 and June 2013 just five of the 148 winners took the annual payment, preferring instant gratification.
Unfortunately after five years, 70 per cent of winners had spent the whole lot. Research does not show how good a time they had, but it does prove that certainty over income makes your money last longer.
The launch of pension freedom is not a lottery win for anyone, but commentary has focused almost exclusively on the rise in flexibility with the annuity being swept away. Even the 5m-plus customers who have annuities are going to be offered the chance to join in.
The point is that pension freedoms are creating a new set of challenges. We all know the old fixed retirement date and traditional ‘cliff-edge’ of retirement has crumbled. People are working and living for longer, and need more freedom and flexibility on how they take their retirement income.
The risk is that flexibility has to be balanced against certainty over income in retirement to ensure savers do not struggle financially when they should be enjoying a comfortable retirement. The challenge for the industry will be to ensure that there are safeguards in place ensuring people a guaranteed income. Innovation is crucial, but it must have a purpose, and build on the best of the old.
The long-term declines in annuity rates, combined with the perceived inflexibilities, have been key factors making annuities unpopular among many advisers and savers. However, they did deliver security of income.
Drawdown of course offered an alternative, with people choosing the drawdown option being generally those with larger than average pots – currently the average fund size in the drawdown market is around £150,000. In 2013, the lowest pot size most providers would accept was £50,000, meaning that the vast majority were forced to buy an annuity.
They chose annuities without advice. Research from Spence Johnson shows that advised annuity sales fell from 68 per cent of the whole market in 2012 to 48 per cent of it in 2013. The gap created by the withdrawal of advisers made room for new intermediaries such as online brokers. They fulfilled a demand, but clearly people are not being advised as much as they need to be under the new pension freedoms.