Pensioners may not be better off going into full drawdown at retirement, a study by LCP revealed.
The introduction of pension freedoms in 2015 meant retirees do not need to convert their pots into an annuity, which would give them an income for life.
This has resulted in a significant drop in annuity sales, with people either withdrawing their pension in full or moving it to a drawdown account to support them throughout retirement.
But recent data from LCP has found that many pensioners should actually revisit the decision of not buying an annuity later on in retirement, as they could get better outcomes by switching.
In its paper ‘Is there a right time to buy an annuity’, the firm created a model looking at 2,000 different scenarios for future investment performance and life expectancy comparing drawdown with annuities.
It discovered that, on average, up until age 67 drawdown should be the preferred way to receive retirement income. But after that, an annuity could be the better option. In all the scenarios, LCP found a ‘crossover point’ between the two products where annuities become more attractive than drawdown – the age when this might occur will change according to the individual and their circumstances.
One of the reasons annuities become increasingly more attractive as people go further in retirement is because life expectancy grows as people get older. This means that pension pots get harder to manage to make sure retirees don’t run out of money prematurely or are forced to live more frugally than necessary to make ends meet.
Possible solutions
LCP suggested there might be a couple of ways on how to help people reassess their finances:
- A mid-retirement ‘MOT’ allowing individuals to review the choices made at retirement are still appropriate years later; and/or,
- Creating drawdown products that default people into an annuity at a later age, with the option to change the decision if circumstances vary.
Steve Webb, co-author of the report and partner at LCP, said: “Whilst forcing people into annuities in their late fifties and sixties was not the right approach, it would be wrong to write-off annuities altogether. This powerful research shows that for a wide range of people there could come a point during retirement when a switch to an annuity gives them better outcomes overall.
“Policy makers need to think how best to nudge people to review their finances not just at retirement but during retirement”.
Phil Boyle, co-author and partner at LCP, added: “The exact point at which an annuity becomes more attractive depends very much on the individual. Our model suggests that for a wide range of people there is an age beyond which staying in drawdown may not generate the best results.
“As people get older, their life expectancy becomes more uncertain, and this creates a real headache for manging your pension pot. An annuity takes that uncertainty away”.
