18th February 2014
New FCA research has concluded comprehensively that the annuity market is not functioning as it should. Around 60% of people don’t shop around for annuities, despite the fact that 80% would be better off by doing so. The FCA research found that the annuity market was unfairly biased to holders of larger pension pots, while those with pensions of just a few thousand pounds were left with little choice. The FCA is on the case, but what should retirees be doing in the meantime? Cherry Reynard looks at the options.
After children or plastic surgery, an annuity purchase is a one of the biggest irreversible decisions an individual can make. They are spending money that has been built over 40-odd years of working, the income received has to last a lifetime, and individuals cannot get their pension pot back if they decide they’ve made a mistake. As such, it is worth retirees spending a little time on ensuring that they maximise the income available to them.
All retirees have three options when it comes to converting their pension pot into an annuity. They can go with their existing pension provider, they can take the ‘open market option’ and shop around, or they can not bother with an annuity at all and look at other options such as drawdown. Compulsion to buy an annuity at a certain age has now been removed.
To help with that decision-making process there are plenty of online ‘annuity supermarkets’ from recognised brokers such as Hargeaves Lansdown, some of the major comparison sites such as Confused.com, or groups such as Saga. Investors simply have to plug in their personal details, plus details about their health and pension arrangements, and a range of annuity quotes will appear. This is all deceptively simple, but – as the FCA has highlighted – there are flaws in the annuity market of which retirees need to be aware.
The first is that it still largely runs on a commission basis. This can introduce commission bias and means that investors need to be alert to the fees they are being charged. The Telegraph recently pointed out the difficulties with taking some ‘high street’ annuity options – says “Firms such as Virgin and Tesco will earn up to 3.25% commission on each annuity they sell. Find a customer with a £100,000 pension pot and that’s an instant £3,250. This kickback is factored into the rates customers receive.”
Tideway Investment Partners, says initial fees as high as 6% of the value of the pension savings are not uncommon and thousands of pounds are routinely handed over to brokers and advisers arranging the pension income facility. This would equate to a deduction of £18,000 commission from a £300,000 pension pot, equivalent to an additional annual income of around £900.
Equally, online brokers and comparison sites may not include all the various options. They may not include all providers, and they may not do a thorough health check. Those with life-limiting diseases such as cancer or chronic heart and lung conditions can get higher annuity rates, but so can those with ‘lifestyle’ conditions – smokers, diabetics. Those with any kind of medical condition should check that they are not entitled to one of these ‘enhanced’ annuities, before committing to an annuity purchase.
The process of choosing an annuity also does not address the timing issue. Online brokers cannot easily assess whether it is the right time to buy an annuity. For example, a retiree may be taking a phased retirement and could get a higher income if they wait another three or four years. Alan Higham chairman of Annuity Direct, says too many people buy an annuity too early in their retirement process: ” Some firms want to sell you an annuity right now, before someone else does, so that they get the one-off commission. That’s fine if you are sure that now is the right time, but it is worth speaking to people who are more concerned that you buy an annuity at the right time for you. These firms will tend to ask you more questions about what you want out of retirement to make sure they get the timing right for you.”
The open market option will usually result in a better deal. The FCA research found that on average the benefit of switching is equivalent to having an extra £1500 saved into a pension just before retirement. It showed that for a pension pot of £17,700 (the average size in its review), buying an annuity from the current pension provider would return an average annual income of £1030. By shopping around for a better rate and switching provider, that annual income would increase by 6.8%, or £71 to £1101. That said, there are some pension providers that offer a number of bells and whistles, such as income guarantees, that can make sticking with them the right option. Again, any process of annuity selection should take this into account.
This all sounds fiendishly complicated, but Higham has distilled it into seven key questions:
1. Will you look at the whole range of choices for taking retirement income?
2. How can you help me decide when is the best time to buy an annuity?
3. When I buy an annuity, will you look at all the rates available on the market or do you miss some firms out?
4. Will you make sure my full medical and lifestyle information is properly collected and given securely to every insurer to provide their best, guaranteed quote?
5. Will you check the small print of my current pensions to make sure I’m not missing out on any extra benefits or will be caught by a penalty that I wasn’t aware of? Will I have to pay you extra to check that?
6. If you are not giving me formal advice will you still check what I choose and tell me if you think I might have made a mistake?
7. How much is this going to cost me?
The regulation may be taking steps to address the problems in the annuity markets, but in the interim, retirees can take their destiny into their own hands. Asking the right questions can make a big difference to income in retirement.