SCOTS nearing retirement could gain from the credit crunch by shopping around for a better annuity deal – but most fail to do so. The level of income paid by annuities is at a five-year high as corporate bonds – key underlying investments used by insurers to fund annuity payments – are producing their highest yields in years because of the crisis in financial markets.
But just one in three of those buying an annuity – as most people have to by the age of 75 – shops around for the best deal, according to the Financial Services Authority (FSA). The rest lose out on potentially thousands of pounds in retirement by sticking with their existing pension provider.
With an intense battle for market share at the top end of the annuity market driving rates up, the issue is back under the spotlight.
"It's a good time to retire if you're seeking the best annuity income with rates at their highest for many months," confirmed David Marlow, director of the Annuity Bureau. "The credit crunch has depressed the value of corporate bonds, increasing yields and allowing providers to pass on the benefit to retirees as higher income on level annuities."
The result, according to Hargreaves Lansdown, is that the average 65-year-old man can now buy an annuity worth 11 per cent more than if he bought it two years ago.
So, how can retiring investors get the best possible income from their hard-earned pension fund? The biggest step they can take is to shop around for the best deal, as there's a widening chasm between the best and worst rates available. Among the top dozen providers alone, the gap is around 15 per cent, but when all pension providers are factored in – including a number of closed-life offices – the differential is assumed to be far greater.
"The rate war is only at the top end of the market between the 12 most competitive providers," said Nigel Callaghan, pensions analyst at Hargreaves Lansdown. "Most insurers offer uncompetitive rates as they know their customers don't look around for better ones."
This is despite the open market option (OMO), introduced in 2002 and allowing customers to use their pension funds to buy an annuity from any provider they choose. Callaghan believes that with too many providers failing to tell customers they can select deals from the whole market, the OMO needs to become the default option. "The market needs reform because OMO take-up has been roughly the same since it was introduced. Whether it's the government, the FSA or the Association of British Insurers, someone needs to tell insurers to bring the OMO to their customers' attention," said Callaghan. "With the government straining under the amount of people needing help in retirement, there must be an appetite for this easy solution."
The problem is compounded by the likelihood that only those who shop around or use a specialist broker will be aware of enhanced annuities.
These are designed for people in ill health or with negative lifestyle factors such as smoking, obesity or a hazardous occupation and typically pay 30 per cent more than the average annuity on the assumption that the payout period will be shorter. It is estimated that around 40 per cent of retirees are entitled to an enhanced annuity, yet last year less than one in ten bought one.
"The typical 65-year-old has 21 years to live. If by opting for an enhanced annuity the annual income from his annuity is 1,000 more, that's an extra 21,000 in retirement," Callaghan pointed out. "Making the OMO the default would mean more people would be more likely to take the enhanced option."
David Cooper, marketing manager at Just Retirement, agreed. "Lots of small insurers only offer conventional annuities, so unless you get advice you will never know about the other types available to you, such as with-profits, enhanced or inflation-linked annuities. Half the people buying an annuity are probably missing out on about 10 per cent of their annual income in retirement because they're not getting clear communication as to what they could do and how to go about it."
But Billy Burrows, managing director of Williams Burrows Annuities, believes the OMO is working in most areas. "At the risk of generalising, most people who have a good sized pension pot either know about the OMO or have access to advice," he said. "Also, a lot of people are getting a good rate from their existing provider anyway, as some of the biggest insurers are among the most competitive."
The problem, according to Burrows, is that too many people with smaller pension pots don't get advice. "The economic cost of an adviser arranging even a simple annuity is probably at least 300. If your pension pot is below a certain size, that cost negates any increase in annuity income."
This means a more imaginative solution than simply making the OMO the default option may be needed, Burrows suggested. "We need to address the value that people are getting from smaller pension pots. Perhaps an organisation should be created to offer an annuity rate that's the average of the top three or four in the market."
If you have a pension with one of the many life offices failing to offer their customers suitable annuity options, there could be some light at the end of the tunnel in the next few weeks. In the Budget report in March, the Treasury said it would address the clarity of communication that retirees get from insurers regarding the OMO and the problem of transfers between companies. According to Cooper, the length of time it takes for pension providers to complete transfers on the open market ranges from seven days at best to 62 at worst.
More info: www.moneymadeclear.fsa.gov.uk