Are annuities fit for purpose?
Most people turn their pension pot into an annual income by buying an annuity. This insurance contract covers the risk of living too long. Insurance is great for protecting you against risk but the problem is that the risk isn't easily spread between the retiree and the insurer – the odds are always in the insurers' favour.
The annuity rates - that determine the amount of income you receive – have been plummeting to new lows due to low interest rates and low gilt rates caused by quantitative easing (QE). As yields and interest rates dropped annuity rates followed down step-by-step.
While interest rates are still low gilt yields are edging up but this time insurers aren't taking the opportunity to increase annuity rates step-by-step. So not only are they still offering pitifully low annuity rates they can also charge a small fortune – between 1% and 4% of the total pension pot – for selling you the annuity in the first place.
According to pension expert Ros Altmann you would have to live on average to the age of 98 before the insurance company loses out. It's a tails you lose, head they win situation.
This all adds up to one question: are annuities fit for purpose?
Is it right to push people to save when they are still invariably still going to go and buy an annuity.
Personally I don't think that annuities are fit for purpose anymore. The problem is that people buy them because they think it's the only option but they don't understand the risks.
They're marketed as no risk because you will always have money but there is a huge risk that the income you receive – on a level annuity - won't buy as much as you age because it won't keep up with inflation.
If you buy an inflation-linked annuity it will cost you a fortune and most people just don't think it's worth it.
Annuities are the norm and insurers are using this fact to, quite honestly, rip people off. There isn't enough information given to retirees about the risks and people are unaware that they're getting a poor rate because they don't realise what the rates stand for.
Are they fit for purpose? I'd say no.