In part two of our investigation into the at-retirement landscape, Charlotte Moore looks at how longevity considerations should should feature in default decumulation
Trustees may currently be directing their scheme members towards cash, annuity or income drawdown options. However, in the future there could be one at-retirement option which offers all three. Designing this product is not straightforward as it requires a number of different features which will change as the member moves further into retirement.
While flexibility is an important consideration of such a product, it is not the only concern. Mark Fawcett, chief investment officer at Nest Corporation says: “Members need protection from outliving their pension pot.” In other words, the product needs to provide protection from longevity. Nolan agrees: “An at-retirement product should guarantee it will provide income for life.”
It’s very difficult, however, for an income drawdown product to provide enough income to last a lifetime. The problem is that is almost impossible to forecast precisely how long you will live. Even if, for example, the average lifespan for a man aged 65 was another two decades, there is still a strong possibility they could live even longer.
This uncertainty makes predicting exactly how long your pension pot should last very tricky. The only product which can guarantee to last a lifetime is an annuity. Fawcett says: “An insured income product is the principal way to manage the longevity risk.” That’s because these products use a ‘mortality pool’ – those who live longer are funded by those who die earlier.
But while annuities may be only solution, scheme members do not have sign up for one the day they retire. Delaying an annuity purchase can be a very cost effective decision. Tim Banks, managing director of the pensions strategy group at AB says: “Our retirement bridge product aims to increase member’s lifetime retirement income by 20% through not annuitising on the day they retire.”
It’s not until a scheme member reaches the age of around 75 that pensioners need to think about longevity risk and take the necessary steps to ensure they will have a life-long income. Buying an annuity before that age is effectively paying for unnecessary insurance.
Another option would be to buy a deferred annuity, which would kick-in at the age 85. However, these products are not yet available in the UK but are being developed in the US.
It’s better to buy a deferred annuity rather than simply purchasing an annuity at the age of 85 because it allows the scheme member to benefit from the mortality credits. This is when those who live for a long time benefit from the remaining pots of those who do not.
If a pensioner were to simply buy an annuity at 85, they would not benefit from the mortality credits and the product would be more expensive.
It’s important to consider what the members would prefer when it comes to finding the funding for these deferred annuities. Fawcett says: “There would be considerable objection to taking 15% to 20% of the pension pot to invest in the annuity at retirement.” A more palatable solution is to take regular smaller premiums.