Buying an annuity hasn’t been the first choice for the self employed retiree, company director or even a member of an occupational, defined contribution pension for some time.
That may not be the case, if a new annuity development by Aviva Life and Pensions catches on.
Annuities provide a pension for life but at a huge cost: the underlying bond rates, which produce the pension income, have been so low for so long, that a 65 year old man with a 60 year old wife who wanted to provide her with a two-thirds pension upon his death might end up with an annual pension income of just c€4,000 a year for every €100,000 saved in their fund.
A single life annuity – with no provision for a survivor – will provide a somewhat better annual income, but when the annuitant dies, so does the income and the fund reverts to the insurance company from which the annuity was purchased.
At best, annuities are a part-solution, perhaps as a small element of the more popular retirement income strategy of the past 13-14 years: the (invested) approved retirement fund (ARF) and, if required*, the approved minimum retirement fund (AMRF).
With ARF/ARMFs, a pension income or just the investment yield can be drawn down each year and should the fundholder die, the remaining money under investment passes tax-free to a spouse or civil partner or into their estate for their other heirs.
It is only at age 75 that an annuity purchase with the remaining ARF/AMRF becomes compulsory; but by then the annuity rates are very generous (because life expectancy is lower) and much of the fund may have already been drawn down.
ADDRESSING THE PROBLEM
Conscious of the poor return from annuities, but also the concern that new pensioners have about staying in volatile investment markets once they retire, Aviva, which only re-entered the annuity market in Ireland last July, has decided to address this problem, at least for one group of retirees – pensioners with serious or chronic health conditions.
Aviva’s new annuity is aimed at people who suffer (or have suffered) from illnesses such as cancer, a heart condition, stroke. They are offering annuity rates up to 30% more, depending on the peson’s age and medical history.
It isn’t fair, says Aviva’s new CEO in Ireland Alison Burns “that a 65 year old with a serious heart condition is paid exactly the same rate as a person of the same age with no compromising health issues” is paid the same as someone who doesn’t. Life expectancy is one of the main dictating considerations in calculating annuity rate risk and this unique annuity addresses that issue.
In the UK, one in four annuities are “enhanced risk”.
With a recent Aviva Consumer Attitudes Survey showing that more than half (55%) of us are worried about not being able to afford a decent retirement and 49% expecting to have to work past normal retirement age (45% of those close to retirement age) the need for more proper retirement planning has never been more essential.
Anyone close to retirement needs to get independent (ideally fee-based) pension planning advice and has to be taken through the complicated post-retirement options of annuity or ARF purchase where applicable. This is especially important for members of Defined Benefit schemes.
Unfortunately, most DB schemes are still in deficit and cannot deliver the promises they’ve made to pensioners, existing workers or workers who have left service early but still expect a part-pension from their ex-employer when they retire.
Some DB employers pay out pension incomes (which are based on final salary and years of service) directly from their pension funds; others purchase annuities that reflect the amount owed. Anyone lucky enough to have an annuitised pension from a DB scheme “are the lucky ones” say pension experts and have nothing to worry about as their income is no longer part of the company’s finances and has been “ring fenced”.
It is the DB members of struggling schemes who have to worry if their scheme is wound up voluntarily by the trustees or involuntarily if the company goes bust, before they retire, as no one can then be confident of getting their final salary/service years ‘pension for life’. As too many workers have discovered (like those at Waterford Glass), they can end up with a tiny fraction of their expected pension.
For members in defined contribution schemes, their pension fund value reflects what has been contributed to it by both the employer and worker and the performance of investment markets.
At retirement DC fund pensioners can opt for an ARF instead of a purchased annuity, but too often if their pension pot is small, it will be mostly absorbed in an AMRF (*where the first €63,500 is set aside if you don’t have independent income of €12,000, and only the annual growth can be drawn down, not the capital). The fund fees and charges, volatility and poor returns just don’t make this a reasonable option when compared to the security provided by an annuity.
Aviva’s new enhanced risk annuity won’t help small fund holders unless they are in poor health, but it is a welcome sign that the life and pension companies are finally trying to address the real concerns that retirees have about matching the need for a decent income with the kind of risk they can tolerate.
It will take a surge in bond rates to restore the pension incomes (for everyone) from annuities that even a dozen years ago – at 6%-7% – seemed modest. This latest product, should if nothing else, ensure that you seek out the best, independent – and comprehensive – advice you can find.
Article by Jill Kerby