I first got involved with retirement options in around 1995. Back then it was generally felt that the requirement for everyone to buy an annuity was inflexible, and that a new way of providing a retirement income was required.
A catalyst for change was the launch, by one of the large life offices, of a ‘flexible annuity’, which allowed a range of more flexible benefits.
The company I was with at the time had such a product on the stocks, and was in consultation with the Inland Revenue before launch.
They advised us not to launch, and then published the rules for income drawdown.
At the time there was still the requirement to buy an annuity at age 75, but this was changed from A-Day with the advent of alternatively secured pensions.
With the changes in 2011, the emergence of capped drawdown and the advent of flexible drawdown, it finally seemed that the jigsaw was complete. So, is that it? It appears not.
While sorting through some papers, I recently came across a booklet entitled ‘Annuities: The case for change’. This was produced by the Social Market Foundation in May 2000, and considered reforms to pensions - particularly the rules on drawing an income. Here’s a quote from the research:
“The current strength of the UK economy has produced inflation and interest rates lower than we have seen for many years. The yield on gilts has been falling dramatically, with steadily declining annuity rates for pensioners.”
Does this sound familiar? Replace the word ‘strength’ with, say, ‘situation’ and the rest of the quote could have been written today.
Obviously, time has moved on and, twelve years later, the situation has deteriorated even further. In February 2000 the relevant gilt yield was 5.25%. In October 2012 it is 2.25% - an increase from the minimum of 2.00% where we had appeared to be stuck.
In twelve years, the background has also changed. Longevity has increased dramatically and retirement ages are on the way up - the norm of 65 for men and 60 for women is changing, and a worst case scenario suggests that the future state retirement age could be near, or beyond, age 70.
Retirement is no longer a one-off cliff edge, but more a flexible period that could last for in excess of thirty years. Annuities have their uses, but this can be a long time to have no control over your capital, and an income that is set at a certain date, based on a particular set of requirements.
Income drawdown is here to stay, but the new regime of 2011 has not quite gone the way that was hoped.
In 2011 drawdown was hit by the ‘perfect storm’ - gilt yields were falling, markets were volatile and the new 2011 GAD rates (which were already lower than their predecessors) were reduced from 120% to 100%.
We now have the situation where, in some circumstances, an annuity can provide a higher level of income than drawdown, and these income levels are generally much lower than people anticipated.
Since the extent of the ‘squeeze’ became evident, there has been a growing campaign for a change to the rules, and a move away from gilt yields.
The Social Market Foundation research I mentioned earlier concluded with a recommendation of total or partial abolition. We now have a total abolition of mandatory annuities, but some of the arguments for and against the move are interesting.
To avoid the moral hazard of people spending all their money and falling back on state benefits, the suggestion is that there could be a minimum income level - we now have flexible drawdown.
One of the current arguments against reform is that funds could be depleted prematurely, but the Social Market Foundation concluded that the moral hazard for such pensioners is very low, and that they are unlikely to change their spending patterns dramatically after retirement.
We also have the safety net of triennial reviews, where the early signs of depletion can be identified and acted upon. To restore trust in pensions, the ability to adapt to external factors is key. Reform will help in this area.
Mike Morrison is head of platform marketing at AJ Bell