With around £100 billion in assets under management, Legal & General is the largest defined-contribution (DC) pension provider in the UK. We conducted a five-year study on our members’ retirement choices during the period 2015-2019.
‘Old age pensions’ used to be synonymous with buying annuities – getting a regular stipend to pay the monthly bills, and the planning and regularity which went with it.
Nowadays, early retirees are likely to be as fond of abseiling as they are of their armchairs. Savers seek increasingly personalised combinations of retirement provision as their income requirements change through the years – and providers need to keep up.
What is more, the start of our Retirement Choices study coincided with 2015’s ‘freedom and choice’. This regulation means that members no longer have to buy an annuity at retirement. Our study is therefore a timely review of how members’ decision-making about annuities may have altered over the past half-decade.
So, do annuities still have a place in members’ retirement provision?
Making late fashionable
Annuitising their pot is now the least likely option to be selected by our members at retirement. The proportion of members choosing to annuitise their pot after they stop working has been consistently low over our period of study, and is in decline.
As the idea of retirement becomes more fluid, members are accessing their pots in more flexible ways.
Many of our members now postpone the decision to retire fully: dipping into their pot to take their tax-free cash while they’re still employed, with an increase in those aged over 65 working part-time.
But we don’t think this heralds the graveyard shift for annuities quite yet. There are some defined and specific uses which make buying a guaranteed income the right option for certain members, particularly when combined with other types of retirement options.
For example, we found that our members are plumping for annuities later on in life, with the average age of buyers rising from 62 to nearly 64. This is a trend we think is here to stay. As people age, the balance of investment risk (the risk of capital and income depreciation of your investments) and longevity risk (the risk of ‘outliving’ your investments) shifts. By choosing not to annuitise, a member is bearing the uncertainty themselves of their pot being required to sustain them for another year or 10 (self-insuring).
An annuity gives members the peace of mind that at least some of their savings will last as long as they do. It also takes away the need to make any investment decisions, as the risks of cognitive and health issues become more pressing.
Our study focused on members who chose to use all of their DC pension pot to buy an annuity. We think that as DC pots get bigger over time (see below), more members may use at least some of their money to buy a guaranteed income via an annuity.
A welcome boost
The general trend that we have seen across our membership is that pot sizes are gradually increasing. Members opting to buy an annuity are no different, with average pot sizes up by £10,000 over the period of study.
However, although the average pot size has grown over time, half the members buying an annuity are still doing so with a small pot of less than £30,000.
Taking 25% tax-free cash from a £30,000 pot (£7,500) and buying an annuity with the remainder could provide a member with an annual income of £1,100 for the rest of their life, based on current annuity rates. This amount will not be enough to live on, but might be a welcome regular stipend to cover some essentials.
Mixing it up
In future, creating a good outcome for members will be about more than just building up as much as possible during the accumulation period. Increasingly, it’ll also be about helping members make the right decisions for them, and providing relevant options to support them when they come to spend their retirement assets.
As pot sizes grow, and legacy defined-benefit pensions dwindle, we expect that retirees will enter income drawdown in ever-increasing numbers. However, the question of whether they can continue in drawdown longer term still remains, as in most normal circumstances no individual can know how long they will live and so how long the money needs to last. Equally, no individual knows when or if cognitive decline may occur. These are not topics that we like to think about, but they are the big unknowns when planning a retirement based solely on drawdown.
While annuities are no longer a one-stop shop, we anticipate that they will still have a place later on in members’ retirement provision, as retirees seek security that they won’t outlive their savings.
We expect to see more guided post-retirement solutions emerging over the coming years, based on the framework which the PLSA set out in its Call for Evidence. These solutions are likely to involve a combination of drawdown and annuities, as most members seek the freedom to spend their money in the early years, but want to make sure they’re taken care of later on.
 The number of members whose choices were reviewed in the study was 16,000 in 2015, 23,000 in 2016, 29,000 in 2017, 42,000 in 2018, and 53,000 in 2019 (rounded to the nearest thousand).
 Small pots are classified as <£30,000, medium pots are between £30,000 and £150,000, large pots are >£150,000.