In 1985 a 65-year-old retiring with a £100,000 pension fund could have bought himself an annual pension income worth £14,500. Some 10 years later, in 1995, the same £100,000 dropped to an income of £11,500; today, the same fund will yield an annual pension of just £8,500, a drop of 70 per cent from the 1985 return.
The annuity-rate crisis has intensified in recent weeks as stock markets have tumbled. Falling interest rates means that the yield on long gilts - the traditional home for the annuities that produce pension incomes - has also fallen.
Financial advisers are doing their best to try and maximise pension incomes for their retiring clients who are obliged to buy an annuity, but the options are very few. There is some hope on the horizon for people retiring in two or three years time if the recommendations of the National Pensions Policy Initiative are adopted.
The Moneywise Annuity Bureau is an independent fee-based advisory agency that specialises in annuity purchases. Its director, Mr Owen Morton of Moneywise Financial Planning, has broadly welcomed the NPPI recommendations on abolishing compulsory annuity purchase. But he notes that the report takes a rather laissez-faire attitude about falling rates, saying that these have been "obviated in large measure by the significant rise in share prices". Not only have share prices now slumped, but, says Mr Morton, near retirees should never have been exposed to equities in the first place. He also thinks the NPPI have "pussyfooted" around the idea of annuity draw-downs and the availability of with-profit annuities.
If there is any "solution" to the current problem of declining annuity rates, he says, it is the availability - albeit exclusively with the Equitable Life - of with-profit annuities.
"The principle attraction of a with-profits annuity, with as its underlying asset-base a mix of ordinary shares, Government stocks and a little cash, is its capacity to distribute growth in the fund on an even-keel distribution," explains Mr Morton. "That is, it smooths out the peaks and troughs as share markets gyrate - as is their wont.
"Unlike a traditional annuity, by dint of its make-up a with-profits one can't compete in terms of security and guarantees and the prospect of a variable income will discourage many. I also have to say that the track record of the current sole provider, Equitable Life, displays the kind of gyration more readily associated with a managed fund than a steady, even-keel unitised with-profits one: in the last three years, bonuses have been from 9 per cent to 20 per cent to 12 per cent.
"Nonetheless, the income return from this annuity is considerably better than anything else on the market. This market is crying out for choice and I'd like to make an urgent call for more players to provide an alternative base of stable with-profit annuities to the conventional gilt-based ones."
A computer model comparing a conventional annuity purchase with a with-profits one shows just how different a return there is.
According to the Moneywise model, a conventional flat pension annuity purchased with a £200,000 fund and returning 8.5 per cent per annum will produce an annual income of £17,000 for the pensioner's projected life expectancy of 15 years. The same fund that purchases an Equitable Life with-profits annuity producing a 9 per cent annual bonus (the average bonus since 1987 has been 11.93 per cent) will produce an annual return of £17,300 in the first year, when the minimum bonus of 4.5 per cent applies, rising every year thereafter. At year five, for example the bonuses have produced an income of nearly £21,000; at year 10, more than £25,000 and at year 15, £30,400.
Even if the with-profits fund achieved no growth whatsoever, and paid out the guaranteed annuity return of 4.5 per cent, says Mr Morton, it would still produce a flat annual income of £17,300 per annum. Since the bonus record of this with-profit annuity fund is more volatile that its name would normally suggests, Mr Morton says that there is nothing stopping the cautious pensioner from splitting his annuity purchase between the conventional gilt-based one and the with-profits one. Such a 50/50 split will produce an annual income of £8,500 every year from the gilt annuity and an income that rises from £8,654 in year one from the with-profits side to £15,203 in year 15. The total annual income ranges from £17,000 in year one to nearly £24,000 by year 15. A solution like this also avoids the pitfalls associated with an escalating or indexed pension in which the pensioner opts for a lower pension income in the early years in order that it keep increasing in line with inflation.
Mr Gervase McCourt, of McCourt Financial Planning in Dublin, independent fee-based advisers, believes all annuity pension quotations should come with a full fact sheet showing a comprehensive comparison between an escalating pension and a flat one. He believes that "in many cases, insurers encourage those retiring to purchase an escalating pension as a `protection' against inflation", based on comparisons of a flat/fixed annuity and an escalating annuity. The client is then "left to make their own decision".
Using a typical example, of a joint-life pension annuity with a five-year guarantee, Mr McCourt found that it took 11 years from age 65 to 76 before the escalating pension reached the same annual payment as the flat pension and a further 10 years to age 86 before the total accumulated pension payment on the escalating one reached the same level as the flat pension. "If the pensioner on the flat pension were to save his extra pension payments (after tax) in the early years and built up a `reserve fund', it would take a further four years (to age 90) before the reserve `ran dry'. "As the average 65-year-old lives for 15 years, there is very little reason to buy a 36 per cent more expensive escalating pension," he says. The Moneywise Annuity Bureau can be reached at (01) 670 5937; McCourt Financial Planning at (01) 661 4800.
