July 2008

Open up all options

For a number of years now, campaigners have battled to raise awareness of the Open Market Option for annuity buyers. This valuable right means that at retirement anyone with an individual defined contribution pension can move away from their pension provider to find a retirement income solution.

It is sad but true that many people miss out by failing to shop around for the best rate on lifetime annuities, instead automatically purchasing one from their own pension provider at what can be an uncompetitive rate.

Buying a poor value lifetime annuity is not the only way that consumers can miss out on the most suitable retirement income solution. As the 'at retirement' market grows and develops in sophistication, Living Time believes that the 'OMO' acronym should instead stand for 'offer more options' - the lifetime annuity is no longer the only game in town for those reaching retirement.

Increasing longevity means that retirement is no longer necessarily a relatively short period between work ending and the average life expectancy being reached. So arranging a retirement income should no longer be simply a case of using a pension fund to buy a lifetime annuity.

There are a host of statistics to show how retirement is changing. Government figures from 2004 indicate that a 65-year-old man can expect to live for another 16.6 years and for a woman of the same age, the figure is 19.4 years. In demographic terms, the 'golden generation' of those born between 1925 and 1935 is rewriting the mortality tables as it enjoys its retirement and the post-war baby boom age group will continue to boost the 'at retirement' market over the next couple of decades.

Growing market

In financial terms, Watson Wyatt, the actuarial consultancy, recently said that the 'at retirement' market for financial products will more than double within five years to over £30 billion a year. According to Watson Wyatt, the 'at retirement' market, which covers both conventional lifetime annuities and unsecured pensions, was worth £13.6 billion in 2007 and is projected to grow at nearly 20% a year over the next five years.

The growing importance of this market is partly the result of the development of personal pensions in the late 1980s and 90s. It has become easier and more common for individuals to take care of their own pension arrangements. In general, it is accepted that the state pension has withered on the vine and as companies have closed down expensive final salary schemes in favour of defined contribution schemes. The growth of the individual 'at retirement' market is a natural consequence of this; over time, the increased emphasis on the accumulation of pension assets naturally leads onto a greater emphasis on the de-accumulation phase when individuals retire.

As individuals live longer in retirement and as more pension funds come to maturity, the focus on the financial planning aspects of retirement will increase. This is why it is important for advisers and product providers to ensure they meet the demands of the 'at retirement' market. Retirees are likely to be in retirement for a longer period than ever before and the right decisions need to be made at the beginning if they are to enjoy fully the benefits from funds they have worked hard to accumulate.

One clear trend here is the widening of retirement income options, under the Government's over-arching principle that a pension must be used to take an income rather than pass it on to successors. Income drawdown was introduced in 1995, giving an alternative to annuities, usually suited to the more sophisticated, better-off retiree. In parallel with this, an increasing range of lifetime annuity options has evolved. As well as investment-linked annuities, there are impaired life and ill-health annuities.

More recently we have seen the development of fixed term annuities and variable annuities, within the unsecured pension umbrella. These developments are to be welcomed, as they can avoid a lifetime lock-in and help individuals find a product to suit their circumstances at different stages of retirement. For example, many of today's retirees could benefit from taking a secure income in the early retirement years while retaining the ability to switch to an impaired or enhanced rate if illness strikes later. Locking into a lifetime annuity too early removes this option.

With retirement now lasting for up to twenty or even thirty years, a retiree's circumstances and financial needs are likely to vary considerably over this period. For example, initially, an individual could be very active, perhaps with a part-time job to help support their lifestyle. As they grow older, they might move into a quieter phase with more predictable income and spending.

Keep options open

Financially, the early part of retirement could also see property down-sizing and inheritances received, with long-term care or other medical costs later on. Using a limited term product such as a fixed term annuity in the initial stages could help retirees chart their course through retirement and respond to changing circumstances in a way that is not possible with a traditional lifetime annuity.

For financial advisers, the increasing range of retirement income options offers a huge opportunity. Retirees will need expert advice to help decide what best suits their circumstances and aspirations. This means that being able to advise on retirement income options will become even more important for advisers in the future, a point already widely recognised. A Defaqto survey last year found that over 80% of IFAs believed that income drawdown would be either important or very important in future. New products, such as fixed term annuities, arguably cater for a larger market than income drawdown.

Judging by the latest Retail Distribution Review ('RDR') statements from the Financial Services Authority, advisers will have to change how they operate in future, in terms of their qualifications and how they give advice. Knowing all of the retirement income options and being able to advise on them will be a key requirement in the future.

For individual retirees, public awareness campaigns are a valuable way of raising the profile of the choice of retirement income options. If retirees are unaware of new products, such as fixed term annuities, it is too easy to be funnelled into a lifetime annuity with no means of escaping.

This is why we believe that OMO should primarily stand for 'offer more options'. Only once the right retirement option for an individual has been chosen, should the process of shopping around for the best rate begin.

Dave Harris
Sales and Marketing Director
Living Time