A Bird in the Hand
Two recent pension surveys caught my eye last week. The first suggested, somewhat unsurprisingly, that retirees prefer a guaranteed income to an equivalent sum of savings.
The report was based on lifestyle survey data and the analysis contained a lot of squiggly charts and tables of data. The upshot though is that increasing guaranteed income appears to encourage social participation (and other activities associated with the feeling of wellbeing) to a degree not matched by merely increasing wealth.
The survey was conducted specifically to investigate issues relating to the pension freedoms introduced in April of this year. These gave many retirees an alternative to simply purchasing a guaranteed income in the form of an annuity. Effectively the freedoms present investors with a choice between a fixed income for life (an annuity) and investing, at their own risk, to provide an uncertain level of income.
It’s not hard to see where the stress comes from. Producing an acceptable income from savings has always been a challenge, one that eludes many “professionals”. The current low rate environment exacerbates this problem. Add in a generalised lack of financial self-confidence, not to mention the intimidating “mystique” surrounding investment, and it’s easy to see why most pension savers are happy to let others take responsibility for their retirement income.
However, even leaving aside the emotional and educational aspects, uncertainty creates real risk and people are prepared to pay significant sums to avoid it. Indeed the entire premise of insurance industry is that people will pay more in premiums than they’ll ever claim from their insurance policies.
Another way of looking at this is from the perspective of an annuity provider. Previous blog entries on this site have illustrated just how expensive it is to buy an indexed-linked pension compared with a level annuity that pays a fixed income for life. Adding indexation sees the provider assume the risk of protecting their clients from future inflation. Even ignoring inflation, providers still run the unquantifiable risk of longevity. It is this, combined with current low interest rates, that make annuities appear such poor value.
Another survey indicated that typically only 6% of retirement income comes from savings. 48% comes from benefits or the state pension, whilst private pensions chip in 42% on average.
These two surveys would appear to support each other inasmuch as savers’ lack of comfort with cash, as opposed to a secured income, suggests that they “value” savings less. Of course there may be practical issues that limit an individual’s ability to save. However, it is a shame that the flexibility of savings is underappreciated.
The slight irony is that the various regulatory developments that have occurred since the vast majority of these private pensions were accumulated have indeed made private pensions a more rational choice as a means of long-term saving. With the 55% Death Tax removed, pension pots can be passed on intact and sometimes entirely tax free. That is a significant advantage compared with seeing your entire pension pot disappear upon the death of you and your partner, simply because you wanted to remove all income uncertainty from your life by purchasing an annuity.
The inescapable, and somewhat unfortunate, result of all this is that pensions have become even more complicated and daunting than ever. Annuities remain an option, but the opportunity cost of buying one has increased substantially now that pensions can be spent or passed on at the pensioner’s absolute discretion. In many ways a pension is better than a trust. The pensioner remains in control of the funds for their lifetime, but can pass them on to their direct descendants tax free.
Ironically this inheritance tax advantage may cause investors to leave their pensions intact and instead rely on non-pension savings for their retirement income. Which neatly brings us full circle to people’s aversion to saving!
Take care out there