Three years on from the 2014 pension freedoms, it is still unclear what product should replace annuities as the dominant source of retirement income. With most defined-benefit schemes shut to new entrants, and annuity yields uninspiring, current retirement flows are into cash and income drawdown funds, with annuities now making up a much smaller part of the pot. This is unsurprising; an RPI-linked annuity purchased at 65 currently offers a yield of about 3.1% according to the Hargreaves Lansdown best-buy tables – hardly awe-inspiring. Income drawdown is emerging as the product of choice, but retirees will understandably worry about running out of money, and avoiding sequencing risk requires expensive advice.
A wait-and-see approach
Surely it makes more sense for the investment industry to deliver a solution that minimises market risks and maximises returns while allowing investors to retain control of their assets? Yet the current lack of innovation in the post-retirement space is disappointing. The natural architects of retirement income are the life insurers, which have the majority of platform assets, customers and actuaries, as well as a track record of pricing mortality and delivering guaranteed income. But life companies seem to be adopting a wait-and-see approach rather than looking to innovate and shape the market by designing new income solutions.
There are a few retail options, which include variable annuity and hybrid drawdown and deferred annuity products. However, cost is an issue, with most products screening as expensive alongside the DC fee cap of 0.75%, and income illustrations, particularly for the variable annuities at around 3%, are uninspiring.
NEST’s retirement blueprint offers a more cohesive vision of a post-retirement market, albeit designed with its target market of low-to-medium earners in mind. It outlines a structure with three retirement phases: a drawdown pot until age 85, a cash pot for one-off purchases, and a deferred annuity purchase at 85. This maximises the time a retiree retains control of their assets before purchasing an annuity when rates are favourable. But currently NEST is only approved for accumulation, and this blueprint merely represents its vision in decumulation rather than an available solution.
Defining a market structure
The undefined nature of the market structure is part of the problem; it would be helpful for the regulator to issue some guidance in this respect and provide a framework in which the industry could design products with some assurance that research and development costs will not be wasted. NEST’s proposal of a defined period for drawdown (until 85) could provide a helpful target outcome for investment managers and life insurers.
We could envisage a target-date version of a drawdown fund, maximising natural income generation through a mixture of equity and multi-asset income funds, supplemented by capital drawdown to a defined end date. This could institutionalise risk management in a much more efficient way than retail investors could achieve by themselves with an advisor. However, without some formalisation of market structure, we worry that the post-retirement market may continue to lack genuine innovation.