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Retirees raiding pensions losing valuable income guarantees
Retirees are foregoing guaranteed annuity rates as they cash in their pension savings.
by Michelle McGagh on Jan 13, 2016 at 15:22
Retirees are throwing away valuable retirement income guarantees by ditching annuities in favour of taking pensions as cash.
Recent data from the City regulator, the Financial Conduct Authority (FCA), showed 178,990 pensions were accessed by consumers from July to September last year, with nearly seven in 10 of the pensions fully cashed out.
Just 32% of pensions were turned into an income through either drawdown or an annuity purchase.
However, the large number of people cashing out their pensions means ‘guaranteed annuity rates’ (GARs) are being discarded.
While annuities may not be popular due to the poor value they have provided retirees in the past, GARs tend to be quite the opposite. GARs were put in place decades ago when gilt yields – which are used to calculate annuity rates – were very high, meaning the amount of income (or annuity rate) provided by the GARs were far higher than the annuity rates on offer today.
However, if retirees want to take advantage of GARs they have to remain invested in the pension and buy the annuity linked to it.
Opting to take the pension as cash or put it into drawdown mean retirees lose the chance to secure a GAR and therefore secure a guarantee a higher rate of income, often double the amount they would receive under annuity rates today.
According to the FCA figures, 68% of GARs were not taken up in July to September, and this figure increased to 79% for pension pots worth less than £30,000 and to 90% for pots of less than £10,000.
Dean Mirfin, retirement expert at Key Retirement, said individuals needed to be aware of exactly what they were giving up before they cash in their pension and lose their GAR. However, a GAR isn’t necessarily suitable for everyone.
‘GARs can be very valuable, however they can also come with restrictions. For example, they may only be valuable if you take them at a certain age and they may only offer you a certain structure of annuity, such as a level annuity, or they may force you to take a joint life annuity or a single life annuity – the rules can vary quite a lot,’ he said.
The restrictions placed on those taking GARs could mean that the guarantee actually loses its value for retirees and neither do GAR-based annuities take into account a retiree’s health. Retirees who are in poor health or have unhealthy lifestyles can buy enhanced annuities (also known as impaired annuities) that pay out more income.
‘A GAR does not take account of your health and lifestyle,’ said Mirfin. ‘It may be [offering] a good rate to some but if they have a health issue, they may be able to get a better rate elsewhere. Depending on the level of enhancement, you could get a better deal than the GAR.’
He said it all comes down to whether an individual feels the income being offered by a GAR is good value for them.
‘People are losing their GARs because they are cashing in [their pensions] but the income may not be as valuable to them as the cash,’ said Mirfin.
‘The income rate, as a percentage, is good but if you do not want the income then you are going to question its value. People who are foregoing a GAR need to do it with their eyes open and need to be aware of the benefits it gives.’
As well as ditching GARs, one of the main problems with annuities pre-pension freedoms was that individuals were not shopping around for the best income deal when they retired.
Despite the ‘open market option’ (OMO) being introduced that was supposed to make it easier for retirees to shop around for the best deal rather than buy an annuity from their pension provider, few are still doing so.
Even now, when pension options have been expanded, 58% of retirees buying an annuity are sticking with their existing pension provider and the majority of annuities purchased are single-life, level income which means retirees are not taking into account their spouses or the impact inflation will have on their income over time.
Moneyfacts.co.uk said annuity rates fell last year for the second year running and have now declined in 17 out of the past 21 years. Over this time, the income provided by a standard level annuity has fallen 56% and a 65-year-old with a £50,000 pension pot can now expect to receive just £2,573 a year from their savings.
Mirfin said shopping around seemed to have declined. ‘It is a major worry that the launch of pension freedoms seem to have sent all the work on shopping around for the best deals into reverse and means thousands of savers are missing out on vital extra income simply because they are not looking for the best or most appropriate deals,’ he said.
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