Long considered the holy grail of risk-free retirement planning, the end is nigh for guaranteed retirement income. The seemingly untouchable defined benefit (DB) schemes and lifetime annuities are looking less certain, as the pension demographic and investment landscapes change.
DB schemes are increasingly in deficit, and many will be unable to meet their financial obligations unless they quickly shrink their membership. Last year’s British Home Stores (BHS) debacle typified these problems and saw savers lose out.
For clients in the early stages of their careers, with good earnings potential and the capacity for loss, a transfer to a personal pension plan could prove an inspired decision. The Financial Conduct Authority (FCA) is missing a key element of risk assessment in its approach to these schemes.
In situations where every client is advised to transfer to a personal pension, regardless of circumstances, this requires further scrutiny. However, when a client is informed and able to benefit from the transfer, as well as understand the consequences, it can make sense.
The risk of scheme default has not been fully considered in the FCA’s guidance. Should too many schemes default, this risk is enormous. If the Pension Protection Fund is unable to deliver on its compensation promise, it will have a crisis on its hands.
This far outweighs the risk of not meeting the critical yield, as it could result in a more significant fall in income for the client at the last minute, leaving no time to create an alternative plan. An early, planned transfer back into client control could mitigate this risk and allow the client to engage in their retirement planning to ensure all bases are covered at retirement.
In many schemes, single members are heavily subsidising married members and receiving a lower income than they might obtain elsewhere. With divorce rates high, this might be more prevalent than we have estimated.
As insurers struggle to make a profit in a significantly smaller annuity market, against a backdrop of low gilt yields and falling demand, they are exiting the industry. This bodes badly for the future of the lifetime annuity.
Not only is there already less competition, which has resulted in lower rates, it seems unlikely the market is sustainable, in its current form, in the long term.
What is the price of a guaranteed retirement income? There will come a point when rates are no longer attractive, and vulnerable clients will be forced to keep their pension fund invested or risk losing out. We need to focus on creating low-risk portfolios for people who need some exposure to risk, but cannot afford to lose their retirement savings.
Is this an opportunity for third-way pension products? I do not think so. These clients are likely to have limited funds and the key will be keeping costs low and managing risk, not hedging it at significant cost. Simplicity is key. The regulator needs to wake up to the urgent need for education around how to invest for lower risk clients, and avoid blanket approaches favouring annuities.
The profession needs to challenge the long-held belief that a guaranteed income will provide the best outcome for clients, particularly those with smaller pensions.
Longevity in savings continues to increase and younger family members rely increasingly on inheritance to make their own way in life. This is why some clients could benefit from the opportunity to grow their pensions for longer before securing an income, while maintaining the ability to pass the pension on for longer.
They need safer and cost-effective ways of doing so. If the FCA can help by balancing out the picture, so clients can see the advantages and the disadvantages of guaranteed incomes, we can have rational discussions with our clients about which option suits their needs.
Hayley North is managing director of Rose & North.