FCA’s Annuity Prompt - closing the stable door after the horse has bolted

 

Anything that helps people get a better deal is to be welcomed so the FCA policy statement on the new annuity prompts looks good.

My only concern is the reliance on the MAS annuity comparison tool because there are some commercial annuity portals which can provide the same rates but with more value-added information. I have just used the MAS calculator and I don’t agree with the top entry but I will not labour the point.

Welcome as it may be the annuity prompt looks like closing the stable door after the horse has bolted. I say this for two reasons; first annuity broking and the technology has advanced considerably over recent years and second, drawdown is becoming the new retirement default and the same logic should be applied to other retirement income options.

Shopping around for the best annuity

My main criticism about the messaging about ‘shopping around for the best annuity’ is that many people shop for the best annuity without understanding what they are shopping for. As I have said before, someone could get the highest possible annuity but that is little use if it is the wrong solution in the first place. Enhanced annuities clearly pay more income but it is not free money because they only repay the annuitant’s capital at a faster rate. In short, good shopping requires superior information on pricing and value and whilst the open market is good at the former, it is very bad with the later especially with intertest rates being so low.

Will drawdown be the next the problem?

If annuities were the problem in the past, drawdown may be the problem in the future and perhaps it is time to apply some of the same logic of shopping for the best annuity to shopping for the most suitable drawdown.

Of course, annuities and drawdown are different solutions. One is an insurance policy and the other is an investment plan. However, annuity and drawdown have things in common when used to provide income.

If the objective is to use drawdown to provide income rather than simply as a solution to retain flexibility and leave money to the next generation, then it matters that the best solution is found. A lower cost drawdown with an appropriate investment strategy should produce a higher income stream than a higher cost drawdown with an inappropriate investment strategy. This begs the question what is ‘an appropriate investment strategy’?

At present, it is not unrealistic to expect a drawdown plan to produce a higher future income stream than an annuity because of the relationship between long term interest rates and equity returns but this could change if yields increase and equity returns go through a volatile period.

In conclusion, it is easy to work out what the best annuity is but is much harder to work out what the best drawdown solution is. The stakes are much higher with drawdown and therefore it is more important that the most suitable solution is found. Just accepting the drawdown offer from the existing pension provider, or transferring to a high cost drawdown with an inappropriate investment strategy may turn out to cost people much more than failing to get the best annuity rate. It is clearly time to start thinking about shopping around for the most suitable drawdown.