A host of ‘third way’ retirement products and US-style variable annuities have been launched in the UK over the last two years, driven by historically low annuity rates and a desire for greater financial flexibility in retirement.
The players include The Hartford, Lincoln National, Met Life, Living Time (AIG), Canada Life, Aegon/Scottish Equitable and the Prudential. Standard Life and Axa are expected to enter the market later this year.
Most of the new products fall somewhere between annuities and Unsecured Pensions - the latter being a form of income drawdown, the facility to keep your pension fund invested in the stockmarket, while drawing an income, instead of buying an annuity.
The US-style variable annuities involve an insurer providing a minimum guaranteed income for life which can ratchet up if the underlying funds rise in value.
This sounds great in theory, but guarantees come at a cost and this has been the main criticism of the new wave of ‘third way’ retirement products.
The guarantee will only benefit you if your fund would otherwise have been exhausted by withdrawals and/or falling stockmarkets before you die.
Insurers offering these products that you are far more likely to outlive your assets than you realise and that the cost of the guarantee represents good value.
Many financial advisers, however, beg to differ, saying that the present roster of products are too expensive to be worthwhile to pensioners.
Research from Fidelity conducted in October 2007 appears to support this view. Fidelity calculated that the probability of a 65 year old man exhausting his capital by the time he reaches age 95 is almost one in 16.
This assumes that he withdraws 5 per cent from a £50,000 fund with a 1 per cent annual management charge and is invested 50/50 in bonds and equities. By adding on a 1 per cent charge for a guarantee, the probability of the fund being exhausted increases to one in five.
But a 65 year old may not live to age 95 anyway. When a 65 year old’s life expectancy is factored in, the odds lengthen to a one in 50 chance, but only if he was not paying for a guarantee throughout the term of the product.
So while these third way products are a welcome innovation, they need further refinement before they become attractive to those reaching retirement today.
Retirees can secure similar guarantees and flexibility by mixing and matching their pension fund and savings via a mix of annuities (with profit, unit-linked, index-linked and so on) and Unsecured Pension (an Alternatively Secured Pension after age 75).
This strategy avoids having to pay for costly guarantees and leaves the retiree with greater flexibility to cope with changing circumstances, such as death of a spouse and the need for nursing care in their final years.
For more on your options at retirement, read the Defaqto guides:
http://www.defaqto.com/consumer/pensions/your-options-at-retirement.aspx
http://www.defaqto.com/consumer/pensions/your-options-at-retirement/guide-your-options-retirement.aspx
Try out the Defaqto Annuity Calculator:
http://www.defaqto.com/consumer/pensions.aspx
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