The government is coming under criticism over its policy of forcing people to take an annuity at age 75.
The value of pension funds has eroded dramatically this year. Since the beginning of October alone, the FTSE 100 has lost 17 per cent of its value – over the year to date, it has lost nearly 40 per cent.
So people approaching 75 who have not yet taken an annuity will be forced to buy one at a time when their pension pot is significantly reduced, meaning that the amount of annuity income they can afford is lower than they would have anticipated. Those who do not buy an annuity are automatically moved into an alternatively secured pension, which only allows a maximum income of 90 per cent of the current annuity rate, and so is even more punitive.
As a consequence, there have been growing calls from opposition parties and pension analysts for the government to rethink its policy – or at least to raise the age limit to 80.
“Those who make policy really need to think about this,” says Ned Cazalet, an independent insurance analyst. “There can be periods where the retirement income can change dramatically in a short period of time. You might be looking at 30 to 40 years of accumulation, then a few weeks of market trauma could wipe that out.”
He says that a person who delayed taking an annuity in 2000 and bought one instead in 2003 would have received about half the income, because of falling rates and lower stock market returns.
But few believe that there is no value whatsoever in taking an annuity. A good reason to lock in now is to benefit from the higher rates on offer, as these are widely expected to fall next year.
Rates have been high this year thanks to high yields on investment-grade bonds, upon which many pension funds rely for income. But if the bond market strengthens next year and prices rise, yields will fall.
“People could possibly lose more by delaying their annuity until next year,” says Tom McPhail, head of pensions research at Hargreaves Lansdown.
“So be careful what you wish for – I think the chances of annuity rates falling over the year ahead are increasing by the day.”
Taking an annuity does not have to mean investors give up all stock market exposure, he says.
Investors can opt for a unit-linked investment annuity – or move into an alternatively secured pension, a form of income drawdown which can allow pension money to be passed on death to heirs, albeit with tax charges of up to 82 per cent.
Billy Burrows, annuity specialist at WBA, suggests people with large enough pension pots could also undertake phased retirement – taking up to 25 per cent as tax- free cash and using it to buy an annuity for a year or two, while the rest of the money remains invested.
Cazalet predicts that variable annuities, which combine a secure income with the prospect of stock market growth, will have a boom period as a result.
“You’ll end up with a load of people under 75 who’ve found their pensions are a lot lower than they thought and who won’t want to be cashed out of equities at an inopportune rate,” he predicts.
“Variable annuities allow you to stay invested in equities, which allows the pension pot to recover but provides protection, taking some of the sting out.” He believes this will prove much more popular than income drawdown, where people take an income from their equity investments, but without the security of an annuity.
Drawdown has been popular in the past few years as the stock market grew, but Cazalet warns: “There are an awful lot of people now who are unhappy about deciding to go into drawdown.”