Living Annuities are currently under the spotlight and likely to be blamed for poor retirement outcomes. However, this is like blaming traffic fatalities on the invention of the motor vehicle.
Taking a step back living annuities have all but replaced conventional guaranteed life annuities as the preferred retirement vehicle to provide a pension at retirement. Introduced over 20 years ago the living annuity’s introduction coincided with a move away from defined benefit retirement schemes in favour of defined contribution.
Defined benefit schemes provided the retiree with a guaranteed pension based on years of service and final salary. You knew exactly how much your pension would be and you cut your cloth accordingly. The fund trustees were responsible for ensuring the fund was adequately capitalized and appropriately invested to provide for the underlying pension liability, which was underwritten by the employer. The primarily criticism was that your notional portion of the fund was lost on death and hence the introduction of defined contribution schemes.
Defined contribution schemes provide no employer guaranteed pension at retirement. Each fund members contributions and those of the employer are invested to provide for a capital amount at retirement, which must then provide for their retirement. The member has the flexibility to decide on how much to contribute and where the contributions should be invested.
Saving for retirement is sacrificing lifestyle today for financial security in 30 – 40 years-time. Given the choice many employees chose consumption over saving adequately for retirement, thus sowing the seeds for the current retirement dilemma. This was compounded by financial ignorance as members could choose how their share of the fund was to be invested resulting in lower aggregate returns as members opted for inappropriate lower risk / return budgets.
Under-funded retirement provision has led to the abuse of what is actually a very good product in living annuities. Living annuities offer the retiree the flexibility to decide where and how their funds are to be invested and most importantly how much they want to draw as a pension. Referring to my motor vehicle analogy this is like giving your 14yr-old your car keys and telling him / her to have fun and then blaming the car for the inevitable crash. Living annuities are not the solution to an under-funded retirement.
In the UK they refer to living annuities as draw-down annuities, which is descriptive of the product. A Living Annuity is a complex retirement product appropriate for sophisticated investors only. If you are choosing a living annuity for the higher income you are in trouble. Get advice. Consult with a retirement specialist who considers all options before investing your life savings.
Mcomm, CFP®, HdipTax
T. 021-851 3746