I’ve come up my best retirement planning idea yet: take up smoking. High cholesterol and a little extra weight could also help. Why? Well, your pension annuity could increase by up to 25% by reporting those signs of lower life expectancy.
This is called an ‘enhanced annuity’, and it’s about the only way I can think of to avoid being utterly ripped off by the annuity industry.
The annuity concept was designed when life expectancy was much shorter than it is today. Annuities are basically insurance policies that absorb your pension pot on retirement and in return offer a stipend until the day you die.
There are countless problems with these policies and the industry that pumps them out to unwitting punters. First and foremost, these policies offer awful returns.
Some firms offering annuities provide an income 30% below the best deals on the market. But the worst part of it all is that most retirees (except the very wealthy) are forced buyers of these things.
If this doesn’t turn out as another mis-selling wreck, playing out in slow-mo, then I’ll be amazed.
And because all of this awful press, the government today announces the annuities con is over.
George Osborne’s Budget statement on pension reform looks radical. And such reform always looks radical at first sight.
I’ve yet to see the full details of today’s announcement, and I will let you know the implications in due course. But the fact that the government is the prime beneficiary of the system, kind of suggests we shouldn’t get too excited.
The government needs this cash
The main reason annuities offer such heinously bad returns is because the insurance companies themselves are forced into one main investment: government bonds.
The idea is that if an annuity provider is going to promise an investor an income for life, then the insurer is going to have to be darned sure it can meet the promise. Not least because if the insurer fails to meet its commitment, then it’ll be the government carrying the can.
So, the government says to the insurer, “Right. To make sure you can meet your pledges, you’ll have to invest in the safest investments in town. You’ll have to buy our bonds!”
But as we all know, government bonds are incredibly expensive. Even before quantitative easing (QE), returns from gilts (or government debt) had been on a downward trajectory for the best part of 30 years. And since QE (where the bank of England is a forced buyer of said bonds), yields have fallen even further. Annuity rates have been squeezed to next to nothing.
If you want an inflation-linked annuity, you’ll get something like 3%. So for £30,000 a year, you’ll need a cool million in your pension pot. Worse, when you do finally die, so the insurance policy dies too. There’ll be absolutely nothing to show for your million.
Investment professionals rightly say that if you’re after a 3% inflation-linked return, then you may as well buy an equity portfolio. And, at least when you die, there’s a good chance the portfolio will be worth more than you paid for it in the first place – a legacy for someone (or something).
In fact, by gradually ‘drawing down’ on your equity portfolio capital as you get older, you can enhance your income substantially.
And the good news is that if you’re rich, and can prove a £20,000 income in retirement, then you can indeed opt for the non-annuity approach. You won’t need to hand your legacy to an insurance company.
Even after today’s announcement, you’ll need to prove an income of £12,000 before you can consider avoiding an annuity. For most savers, that’s going to be all but impossible. I suspect most retirees will be stuck with annuities.
Everyone’s dumping government bonds
As we’re all painfully aware, our government, like most in the West, just cannot seem to kick that spending habit. Which means every year it needs to issue more and more gilts. The problem is many investors are dumping government bonds.
Pimco is the world’s largest bond asset manager. Not only has it been cashing out on these expensive bonds on behalf of investors, investors themselves have been cashing out of Pimco. This week, analysts Lipper announced a massive turnaround in Pimco’s fortunes. Over recent years, Pimco has consistently been in the top-five for investment funds, if not taking the number one slot.
However, last year, not only did the fund fall out of the top-five, it fell out of the top-25! Like I say, bonds, especially government bonds, seem so yesteryear.
It’s a story the globe over. China has been dumping US Treasuries. It’s now gearing up for a ‘hard asset’ future, investing in everything from real estate, to agriculture and gold. Who wants near-on bust government debt?
And here’s a real sign of the times. London’s biggest council pension fund this week disclosed that it had boosted its assets by a massive 17% by dumping gilts and switching to equities last year.
You can bet your bottom dollar that other pension funds will be looking on enviously. Perhaps trustees will wonder what the hell they are doing with all this government debt that yields next to nothing and which looks less ‘risk-free’ with every passing year.
Universal pension plans: the government strikes back
It’s against this backdrop that you have to ask yourself the question: is the government really going to allow pension investors the freedom to bypass a scheme that’s known to bring billions and billions of pounds from forced gilt investors to the table?
No. I thought not. Drawdown is an option likely to be left only to the privileged few. Moreover, the government is in the middle of rolling out its universal pension plan. That is, a plan that pushes just about all employees in the private sector into a pension plan. And that means more money for the government. It’s what you might call a ‘book-balancer’ for the bods over in Whitehall.
It’s what governments always do. They balance the books by tinkering with long-term assumptions. Much better that, than actually have to deal with hard realities in the here and now.
Anyway, the point is that for most UK citizens, this means if you’re saving into a pension, then chances are you’ll end up with a scraggy annuity. Given today’s more important Budget announcement, that Isa limits are to be increased to £15,000 a year, then maybe more savers should reconsider where they’re stashing retirement savings.
As we’ve seen today, the government can change the rules on pensions at the drop of a hat. Much more difficult to do so with instant access and tax-free Isas.
Like I say, I’ll let you know about the full ramifications of the annuities deal in due course. But I can pretty much guarantee one thing: it’s not going to be as good as George Osborne just made out in front of Parliament.