Jam today, jam tomorrow or jam for your insurer?

Pension freedoms have therefore broken the previous retirement income model, but has the industry kept pace with this change? Have we seen the product innovation many anticipated would fill the void left by the demise of annuities?

The simple answer to this question is "no", but a different question might be whether we actually need product innovation?

Before we tackle the second question, let’s look at innovations we have seen. 

In terms of providing a secure income for life, annuities are the only solution that are guaranteed to tackle the risk of living too long. For people not willing or not able to take on the risk of an invested solution, annuities remain the go-to retirement income solution.

Annuities are often maligned for the fact if you die relatively young, the insurance company will keep your money. Due to HMRC rules, the maximum annuity guarantee period was only 10 years, but post freedoms, new rules have allowed annuity providers to offer guarantees for up to 30 years. So, if you do not want your insurer to keep your money you can buy a long guarantee.

The table below shows current rates (from the MAS website) for different guarantees, as well as the amount of capital each guarantees to return. Rates are for a healthy 65-year-old buying a level annuity.

Clearly, the longer the guarantee the more likely you are to call on it and hence the lower the income you are going to receive. The idea of guaranteeing more than the original capital is paid out will be attractive for some, but one wonders if the attraction of ‘jam today’ will be too compelling versus the idea of ‘jam tomorrow’ or ‘jam for somebody else’.

With annuities now being shunned by such a majority, one might expect much greater innovations in other areas. Perhaps the biggest innovation we have seen is in the hybrid product space, with products that look to provide a combination of annuity and drawdown, or security and flexibility, under one wrapper. 

Retirement Advantage and Partnership Assurance are two companies that launched products in this space, albeit only the Retirement Account from Retirement Advantage is currently available. This product allows an annuity to be held under a drawdown wrapper with the remaining funds held in drawdown.

One of the key innovations is that the product provides some flexibility, allowing annuity income to be paid out or switched off and retained within the tax-efficient drawdown element. This is a neat solution and one could argue it is a good way for all annuities to be written in future.

It also works to deliver a cost-effective combination solution for the many average size pension pots and some larger pension pots where perhaps only a relatively small part of the fund will be retained in the drawdown element. However, packaging the annuity and drawdown together does come with some compromises; a reliance that the provider’s annuity rates are competitive and will remain so, and potentially reduced investment choice and flexibility. 

It is interesting that the Retirement Account remains an advised sale only and it will not be long before it and/or similar products appear in the direct to consumer space, where it is likely to have appeal. Research done by the CII showed that 41 per cent of people approaching retirement would like to use a combination approach, although I suspect that is mainly down to people’s lack of understanding and a belief that having a combination will mean at least they got one bit of the puzzle right.

The investment industry would tell us it has delivered many new solutions to tackle the various pension freedom conundrums, but one could argue the new multi-asset and diversified growth strategies are little more than managed funds and with-profit funds in sheep’s clothing. These strategies, used in isolation, offer a one-size-fits-all approach that is no longer fit for purpose in the world of pension freedoms, where everybody’s retirement will be different and personalisation is key to good retirement outcomes.

Investment strategies need to reflect someone’s need for cash and income, particularly in the short term, as well as their personal circumstances and appetite for investment risk. Tailored investment strategies have never been so vital.

If we look specifically at multi-asset versus a multi-fund approach, someone who needs income would need to sell units in the multi-asset fund, which would be taken from all asset sectors. This would result in crystallising gains in assets that had done well and losses in assets that had not. If an investor owned all the assets in isolation they could choose to extract income from the assets showing gains, avoid crystallising losses and naturally rebalance the portfolio at the same time – a more effective way to generate income and tackle the potential problem of sequencing risk.

There will be more innovation in the future. Deferred annuities have been mooted, but one wonders if the lack of a product to market indicates the pessimism of consumer interest. I am sure we will also see product innovation for uncrystallised funds pension lump sums (UFPLS) and drawdown solutions that try to package a simple solution for the growing number of people who are failing or unwilling to take regulated advice – but probably not the innovation those same consumers need to achieve the best retirement outcome. 

Let us go back to the earlier question of whether we actually need innovation. Even before pension freedoms were announced, Intelligent Pensions had campaigned for more people to be aware of the ‘annuity alternative’ solutions that existed. I would argue the building blocks are, and always have been, in place to help people achieve good retirement outcomes and the major challenge now is less about product innovation and more about better use and understanding of the existing product set.

The evidence is growing that many do not understand the choices and are making poor retirement income decisions:

•    The Pensions and Lifetime Savings Association (PLSA) found 53 per cent of would-be drawdown investors believe it will provide a guaranteed income and one in four thought there would be no risk

•    A Citizen’s Advice survey found that a third of people with funds of more than £100k were cashing them in and holding them in their bank accounts

In addition, we know people are using default glidepaths that do not match their retirement income needs. Furthermore, some drawdown investors are taking too much in income withdrawals and risk running out of money while others are taking too little and compromising their standard of living. Then there are the scenarios people often choose to ignore such as inflation, longevity and long-term care costs. 

Retirement income planning can be complex; there are many risks at play, particularly for those who remain invested. Drawdown, by its very nature, becomes progressively less suitable as people get older – suitability and income levels need to be constantly reviewed against changing client circumstances and market changes. 

For many, the flexibility of drawdown in the early years and security of annuities in the later years will be the most appropriate strategy. For others, continued drawdown, annuity, cash-out or a combination of the three might be the best approach. It all depends on the individual’s priorities, objectives and circumstances. The solutions are available to deliver good outcomes, but people are struggling to identify and manage the correct solution for their circumstances. 

We do not need tremendous innovation in retirement income products and investments, what we need are better ways of helping people access guidance and advice so they can safely and effectively identify the retirement income solution that is best for them.

Andrew Pennie is head of pathways at Intelligent Pensions

Key Points

We have not seen the quantity of product innovation many anticipated would fill the void left by the demise of annuities.

One key innovation is a product that provides some flexibility, allowing annuity income to be paid out or switched off and retained within the tax-efficient drawdown element.

There will be more innovation in the future with deferred annuities being mooted.