The decisions we make at retirement are some of the most important and far-reaching we will ever make. Helping clients to understand their choices, though, means cutting through well-established intuitions.
If you tell a 65-year-old man he will have to live for 18 years before he will have received the value of his purchase price, he may well think he is getting a bad deal.
If you tell him that with inflation-proofing he will have to wait even longer (a total of 22 years) to match the nice steady income he would get with a level annuity, he will think it is even worse. Living an extra 22 years, though, is not an unlikely scenario; according to the Government Actuary’s Department figures, this is slightly below average expectancy for this group of men.
More importantly, the client needs to understand what his position will be if he has not died by the age of 87. He could spend another 10 or 15 years with little to live on. Even at today’s low rates of inflation, his pension will have nearly halved in value, and state provision may not be enough to compensate.
Procrastination can sometimes be a good thing: some people can put off or even avoid this decision. The older a client is, the less time there will be for inflation to affect their income.
The Pensions Income Choice Association has done sterling work in highlighting the need for potential annuitants to shop around for the best rates. Less attention has been given to its other contention that annuitants need to be sure they have chosen the most suitable retirement product before they shop around for the best rates. Choosing the wrong retirement vehicle or the wrong options attached to that vehicle can make a bigger difference than not obtaining the best rate.
Annuities come with a number of choices, yet the most commonly selected is a level single-life annuity. There are two reasons for this. First, people who have saved for years want to be able to spend their own money as and when they please, and do not appreciate attempts to encourage them to make it last longer.
Second, people like to think they are getting a fair deal. In annuity terms, this means they think they are entitled to get their money back, plus any investment returns made by the provider. Taking a lower level of income at the outset will only pay off if the individual lives long enough. It is a gamble in which few understand the odds.
Drawdown may be one option worth considering. Fixed-term annuities can also be used. It is possible, too, to select an investment-backed annuity instead of escalation.
Clients who receive the benefit of financial advice can be guided through these choices and their associated risks, and choose when to make the final commitment to a fixed-annuity shape.
Fiona Tait is business development manager at Scottish Life