There’s nothing quite like a catchy or sensationalist headline to grab your attention and so while I don’t normally read Personal Finance (it’s largely contemptuous of the work we Financial Planners do) the lamp post banner stating “Shocking findings on living annuities” was enough to make sure that I read the edition on Sat 2 June.
Under the headline in the paper “Most living annuity pensioners in danger of running out of money” it appears, yet again, that the editors of the newspaper have it in for Living Annuity products rather than addressing the real issues.
The article goes on to report on research produced by ASISA that almost 70% of pensioners are drawing more than 5% of their income in the initial years which reduces the longevity of their capital and therefore their income too. The article seems to imply that it is pensioners with smaller capital amounts that are most in danger of running out of money (because their draw down is too high) and that they should not be using living annuities but rather the conventional life annuities through insurance companies!
To suggest that pensioners might be better off by using conventional life annuities is disingenuous at best. I would like to propose that it is precisely because the conventional annuity rates are so low (and that there is no underwriting of these annuities) that “poor” pensioners have turned to living annuities. Recent quotes we did for a pensioner revealed that he was only able to get an income of around 5% pa (increasing with inflation) from a conventional joint-life annuity. This is no more than he would be drawing from a living annuity under normal circumstances. Given that he wants to potentially leave a legacy for his kids he has opted for the living annuity route.
To my mind though, the real issue here is not “living annuities versus conventional life annuities” but rather that most pensioners have not saved enough money for retirement. As a result they are not able to generate their required income from the conventional or living annuities and are therefore turning to the (flexible) living annuities where they can at least “survive” by making a higher income draw even if it means that they run the risk of their capital running out. In most of the cases that we have come across, this higher income draw is done with the full knowledge that the capital will most probably run out before they do. If the goal of treasury is “sustainable incomes for retirement” then the conventional life annuity is not an answer either and especially not the conventional annuity without an escalating income (which appears to be the one most frequently mis-sold)!
People need to be encouraged to save more for retirement and while treasury’s initiatives appear noble, it is my opinion that they will in fact result in fewer people retiring financially independent. For example, the very strict enforcement of the Regulation 28 asset class exposure will probably mean that most younger investors will end up taking too little risk in their pension funds and as a result will have less capital at retirement than they would have if they were allowed to take on more volatility risk. There is an obvious conflict of interest between a 30 year old investors asset allocation needs (he/she has a 30-35 year time horizon) and the average regulation 28 “balanced fund” where the fund it typically managed with a 5-7 year time horizon. In fact, recent simulations we ran show that investors would be significantly better off using an equity ETF over a 30 year period than using an RA (despite the obvious tax savings from the RA) and when this information goes mainstream we could see younger investors shunning RA’s and pension funds – who was asleep while that legislation went through?
Then there is the proposal to cap retirement contributions – I thought the aim was to encourage people to save for retirement, not inhibit them? Why the cap on what people can put into their retirement funds? Did the regulators not realise that any money in a RA or pension fund is “locked-in” to SA while discretionary savings can leave the country at any time?
Added to the above is the fact that people are living longer but we are still forcing them to retire as if they were only living for 10-15 years post retirement. If we are going to live longer then we need to give people the option to defer retirement age by 5-10 years (at least). It is almost impossible to fund 40-50+ years of income draw from 35 years of contributions (especially given the incredible levels of debt in this country).
Sadly though it seems that in a typical knee-jerk fashion we are going to be subjected to even more legislation and more legislation means more costs and more costs means that the consumers (the very people the regulators are trying to protect) will end up paying more (for advice and products). Add to this that the most likely outcome of increased legislation in the advisor industry will be fewer independent advisors and more large “brokerages” and this is also not good for consumers.
It seems that the pendulum is swinging to the other extreme and when it swings it appears that little thought is given to the practical application of the legislation. The living annuity income draw table (from ASISA) that is now part of all application forms is an example of poorly thought through “legislation” – it was clearly designed by actuaries for actuaries and not for the general public. It is far too complex for Joe Public and as a result is largely ignored – there are far better ways to show people when their money is likely to run out than an unnecessarily complex table that seems to ignore the effects of inflation on investment returns!
Rather than subject everyone to more onerous and costly legislation the regulators should adopt the concept of “libertarian paternalism” as proposed by behavioural finance professor Richard Thaler. His thesis in the book “Nudge” is that we know people make bad decisions so how can we help (nudge) them to make better choices while not taking away their freedom to choose? Stricter legislation will only decrease the choices we have and quality of life is often about the ability to make choices. It’s a long shot but perhaps this might “nudge” the legislators in the direction of sanity?