Annuity Purchase - Open Your Mind To The Open Market Option

About one third of people reaching retirement exercise their rights under the open market option (OMO) to shop around for a better retirement income deal. This suggests two thirds of those buying a lifetime annuity – or more than £4 billion a year in cash terms – roll their funds straight into a lifetime annuity with their current pension provider.

With the best lifetime annuity providers paying about 20% more income than the worst, retirees are collectively losing out to the tune of hundreds of millions of pounds each year by failing to look for a better deal.

It is always easy to spot highly competitive consumer markets – just look at the scale of advertising and marketing that goes into convincing us we can save a few hundred pounds perhaps by swapping to a cheaper car or house insurance deal or energy supplier.

But when it comes to retirement income solutions and potentially thousands of pounds of extra income for those who need it most, the lack of activity at informing the public of their options is striking.

This has not escaped the attention of the government, which set up the currently ongoing Open Market Option review as an acknowledgement that consumers are being poorly served. This is despite OMO first being introduced nearly 30 years ago and a review in 2002 that insisted pension providers had to make customers aware of their right to take their money elsewhere.

The message has obviously yet to sink in with consumers, and with so much at stake some fresh thinking is desperately needed to help the public make choices that are likely to be one of the biggest investment decisions they will ever make. Far too many still believe that at the point of retirement they have no options but to buy a lifetime annuity despite widespread reservations about low returns and lack of flexibility.

One clear message any OMO proposals need to send out is that the open market option is the right to shop around for a better retirement income product, not just for a better lifetime annuity.

This is a CRUCIAL point.  

Income drawdown may appeal to the wealthy, but recent innovations such as fixed rate annuities allow risk-averse clients to receive a potentially higher income than an equivalent lifetime annuity with income and capital guarantees while retaining the flexibility to later swap to a new income plan that best suits their circumstances.

Pension providers still have a strong influence over their clients to roll pension pots over into their own lifetime annuities. There is a widespread understanding in the financial services industry that the majority of clients could find better value elsewhere in the market, but the rules effectively still put the pension company into pole position for receiving those funds.

Although there is no compulsion to buy until age 75, many rush the decision by buying at the point of retirement in their early to mid 60s. This is despite the main benefit of annuity purchase – the extra income benefit from mortality pooling – being so much lower at that young age.

The client literature needs to point out more clearly the benefits from shopping around and the advantages of seeking independent financial advice. Advisers should not be able to benefit financially from keeping those funds with the pension company, and the pension provider should be obliged to transfer funds more quickly to alternative providers.

People only have one chance to buy a lifetime annuity and usually have no experience to fall back on, which explains why advice is such an important issue at this vital time of life. Lack of education and public understanding remains a huge stumbling block.

Just the fact that pension money is kept at arm’s length is unhelpful because it discourages people from taking personal responsibility for their funds when they should be careful with the investment decision as they would if it were cash in hand.

Key Considerations:

Take care when approaching retirement. What you'll probably be asking is from which pot of money to generate your target income from. Just because you have a private pension fund(s), don't automatically assume that you have to purchase an annuity there and then. If you do purchase an annuity, make sure you shop around as once bought, you cannot reverse the decision.

ACTION POINT

Make sure you get impartial advice, whether in person or from a specialist service. Don't make the mistake of making such an important decision in isolation from all your circumstances, however, as buying the annuity now may not be the best option.

NB The bulk of this article has been provided by Kim Lerche-Thomsen, Founder and CEO of Living Time.