Guarantee drawdown vs annuity: Does value override cost?
The value of a guaranteed drawdown product which insures against the client running out of money while staying invested make the premium worth paying, argues Barry Cudmore, managing director, Aegon Ireland
The income generated from traditional annuities was on a downward trajectory even before the pension freedoms were introduced in April 20151. To compound issues, the zero-bound interest rate has been cut even further to 0.25% and, along with the recent Brexit vote, has sent long-term Government bonds yields – which determine the income level that annuities pay – crashing to record lows2. So ABI statistics3, showing a major revival in their popularity among retirees, raises concerns.
Certainty in retirement is all well and good, but locking up the entirety of someone’s money in an annuity kills the flexibility the pension freedoms were rolled out to bring.
While a traditional annuity is the ‘cheapest’ way to guarantee income for life, it is rarely fit for purpose in a world where a longer and a more varied retirement means people have changing wants and needs.
Even those invested in naked drawdown risk running out of money: for example the volatile markets could have wiped up to two years of retirement income off the savings pots of those entering drawdown between April 2015 and April 20164.
These are just some of the risks a client faces in retirement and managing these risks is no mean feat. It’s a complex business that takes a high degree of expertise. Nevertheless, advisers aware of the seismic landscape shift have a duty to both highlight and mitigate these risks for their clients, so that they do not end up with a lack of funds in later life. They can do this simply by looking at the other alternatives that are available.
Cost and value balance
It’s essentially a question of deciding between cost and value: does paying for a slight premium on a pension product matter more to retirees than the ability to guarantee a minimum level of income throughout the entirety of their retirement, alongside the access to cash whenever needed? In most cases it wouldn’t.
One alternative that meets these needs is something called guaranteed drawdown. This product provides an attractive alternative by taking the key benefits of both an annuity and flexi-access drawdown. It guarantees income for life at a minimum level, gives exposure to the market, and provides access to cash when needed. Yet, despite the product gaining momentum in this country, few providers are bringing this to the marketplace despite the much changed later-life landscape and environment.
The expertise used to develop the product doesn’t come free, but the utility it provides, insuring against running out of money, is unquestionable.
An asset with similar importance is a house. Of course, insurance comes in handy when something unexpected or unlikely happens so, as an adviser, would you feel comfortable advising a client not to protect their house and let it go up in smoke in the event of a fire? The likely answer is no, so why let them with their pension savings?
These products are becoming even more important as a result of a more varied experience in later life. With more people at retirement age – and living longer5 – the chances increase that, without some form of guaranteed income, money could run out.
One of the biggest fears of retirees is deprivation in retirement: running out of money or not having access to cash in the event of an emergency.
It’s high time that more innovative products are introduced to the market and this would be something we’d welcome.
People should have the opportunity to live out the retirement they want, without any sleepless nights. That surely is in keeping with the spirit of the freedoms and, if it costs a little bit more to guarantee a safe retirement, it’s worth it.
4 The sustainable income figure is based on a 99% chance of not running out of funds between now and age 95. If the client had taken the 2.53% withdrawal rate in 2015, and wishes maintain this withdrawal rate then their fund will run out between 1 and 2 years prior to age 95 for the fund – Aegon/eValue research.
5 ONS Population estimates – https://www.ons.gov.uk/releases/populationestimatesforukenglandandwalesscotlandandnorthernirelandmid2015
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