Staff nearing retirement face a crucial choice when it comes to buying an annuity.
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- Employers should encourage staff to consider their retirement options five to 10 years before their retirement date.
- By disclosing information about their lifestyle, for example whether they are overweight or a smoker, employees could get a more beneficial annuity rate.
- Employees should be encouraged to shop around to get the best annuity, and not just accept the one offered by their pension provider.
There has been much talk about annuities recently, with the launch of the Financial Services Authority’s (FSA) thematic review into annuity pricing in January, and the publication of the Association of British Insurers’ (ABI) Code of conduct on retirement choices on 1 March. Both highlight the importance of employees getting a better understanding of their options at retirement and how their employers can support them.
We asked some experts to share their views on the top tips employers should give staff about annuities.
1: REVIEW YOUR OPTIONS NOW
Buying an annuity is a hugely important choice, and one that an employee should not make just before they retire. Dr Yvonne Braun, head of savings, retirement and social care at the ABI, says: “If you buy an annuity, it is a one-time decision. You can’t reverse it, so you have to make sure you get it right. If you begin to engage with the process early, it is really useful. Employers can prompt their employees to do so, because they will know when people are nearing their retirement date.”
Although there is no longer a default retirement age, employers should have a view of when staff are nearing that time, and it is a good idea to send out communications about annuities at certain stages. Alan Higham, chairman of Annuity Direct, says: “I would put the first communication point at five to 10 years from the retirement age of the pension scheme. At that stage, what [employers] are trying to do is prompt the person to think more about retirement, just something short and simple that gives the employee a way to get further information if they want it.”
It is important to start the conversation that far in advance so staff have all the information they need to make appropriate choices. Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “By their late fifties, people need to think about when they may be able to retire, how they are likely to move into retirement, whether it will be a cliff edge or a move into part-time working, whether they will want to buy an annuity or will want to run a drawdown plan.”
2: DO NOT BE SHY
Annuities are important because they will secure an employee an income for their retirement, says Robin Hames, head of marketing at Capita. It is therefore important, when discussing annuity options with a provider, that an employee discloses all personal information.
“Up to about half of retiring employees could get further improvement to their retirement income by disclosing some medical details,” says Hames. “The difference between an impaired life annuity and a normal annuity can be as much as a 25 to 30% improvement.”
If an employee is a smoker, is overweight or has had a minor medical condition, they may be able to get an improved rate. “Even if they go through the open market to source the best annuity rate, it will always be based on average life expectation,” says Hames. “But most people aren’t average, and if their life expectation is shorter, they can get a better deal in retirement. Disclose everything, because there are specialist providers that will give enhanced annuities based on specifics.”
3: CONSIDER THE FINER DETAILS
An employee must consider the finer points of an annuity. For example, do they want to provide for any dependants? The ABI’s Braun says: “If they want to make sure the income continues if the employee dies before their spouse or partner, they should think about going for a joint annuity. If an employee chooses a single annuity, the income will stop with their death. Also, they may want to think about inflation protection and buy an index-linked annuity if that is important to them.”
Employees also need to consider whether they have pensions left behind in previous employments, says Hames. “They need to think about all the money they have, and what sort of things they want. Do they want to inflation-proof their income or not?”
The choice of product is vital because it will make a difference to both the employee and their family, Braun adds.
4: SHOP AROUND FOR THE BEST DEAL
Lastly, staff should shop around for the best possible deal. The ABI’s code aims to make the benefits of shopping around clear, and suggests sources for staff to find further information. But McPhail warns that there are some areas of concern about shopping around and workplace pensions.
“If an employee is a member of a trust-based occupational pension scheme that is not administered by an insurance company, they will not be covered by the code, and there is no guarantee they will be encouraged to shop around,” he says.
If an employer offers a defined contribution (DC) pension plan, it should ensure it is feeding it into a comprehensive shopping-around service, he adds.
Braun recommends that employees do not just take the annuity offered by their pension provider, but look at competitive deals. For example, websites such as the Money Advice Service offer comparison tables.
Viewpoint: Mel Duffield, head of research and strategic policy, National Association of Pension Funds (NAPF)
For staff saving in a defined contribution (DC) pension scheme, choosing the right annuity at retirement is critical. This is the point at which the employee’s pension pot is at its largest and when they stand to lose the most, both from their own and their employer’s pension contributions, by making a poor decision or simply failing to act. Reaching retirement and purchasing an annuity is a one-off decision for the employee, so it is also irreversible if they get it wrong.
For many employees, shopping around to get the best annuity deal will result in a slightly higher income, perhaps a few hundred pounds a year. But over a typical retirement of 20-25 years, a few hundred pounds a year soon stacks up.
The greatest risks are when an employee either chooses the wrong type of annuity for their needs, for example if they don’t realise they have no inflation protection or accidentally fail to make any provision for their spouse, or if they get the wrong rate by failing to report lifestyle or medical conditions that could mean they are entitled to a much higher rate through an ‘enhanced’ or ‘impaired’ annuity. In some cases, an enhanced or impaired rate can boost income by 20-30% compared with a standard rate.
Providing employees with information and signposting them to websites that can help them shop around, for example the Money Advice Service, is helpful, but still leaves them to navigate their way through a complex and confusing market.
In the vast majority of cases, shopping around still requires staff to purchase an annuity through an adviser or broker. Employers can play a key role here by taking steps to appoint an independent adviser or brokerage service for their DC pension plan that can actively guide employees through the process of buying an annuity. The NAPF will provide more guidance on the steps employers can take later this year.
FSA AND ABI GUIDANCE ON BUYING ANNUITIES
The Financial Services Authority (FSA) is conducting a review into the way annuities are sold. It began in January 2013 with discussions about a thematic review with the industry.
- The review will be in two phases. The first will focus on the level of detriment employees may face from not shopping around for an annuity. It will include a pricing survey of all annuity providers that will compare the rates available through different distribution channels.
- The second phase, which will depend on the first, will look at whether annuity providers’ processes help or hinder employees shopping around.
The Association of British Insurers’ (ABI) Code of conduct on retirement choices aims to help staff understand their options at retirement, choose the right annuity for their circumstances and shop around for the best deal. The impact of the code will be reviewed in 2014. The code aims to improve employees’ confidence in getting the right deal by:
- Providing clear, timely information to help people understand their options. At least two years from retirement, the insurer will encourage the individual to consider their options. Six months from retirement and again at least six weeks from retirement, the insurer will send details explaining the options, such as combining small pension pots, and shopping around for the best annuity.
- Explaining the different ways to take retirement income, including providing for dependants, lifestyle or medical conditions that may make them eligible for an enhanced annuity.
- Encouraging shopping around for the right deal. The benefits of shopping around among other providers will be highlighted, as will sources of advice. Insurers will no longer include annuity application forms, so there is less chance staff will buy from their current provider without shopping around.