The main objective of saving for a pension is the end result of retirement and drawing of pension income and the Fund must be large enough to give adequate payments and survive the life expectancy of the pensioner. This is achieved for the majority of private pensions by means of an annuity.
An annuity is a form of co-operative in which funds are pooled and the survivors benefit from the earlier death of other members. Usually run by Insurance Companies, they are based on complex actuarial calculations derived from Life tables and mortality rates.
At retirement, funds still have an earning capability and the resultant income can extend the life of the fund, in some cases it can even meet the pension payments; in many ways it is not logical that funds should terminate at retirement and payment arrangements are therefore becoming more flexible.
The population decline from age 65 can be balanced against the fund decline for any given payment and investment income levels in a straightforward spreadsheet calculation to establish the sustainable payment in which the fund and population finish at the same time. This can be done for the existing or any future over 65 population decline distribution.
Such calculations show that a 4% investment income can sustain a payment level of 6%, inflation increasing by 2.5% per year, even with the latest 25 year projected population increases and has been used as the basis of pension yield factors.
Annuity returns have been dependent on the stable returns of State Gilts and Bonds, but these have been subject to increased speculation and market fluctuations making them unstable, in the 1980’s rates were at an unsustainable 16% and have dropped steadily to 6% and even 4% for an inflation proofed annuity.
This is another major factor in the poor returns available from annuities; a drop from 6 to 4% means that a given fund will only yield two thirds of what it could be and fluctuate wildly even whilst setting it up. Over the past six months the pension yield from a £50,000 Fund has dropped from £3,240 to £2,600 per year for an annuity which does not increase with inflation.
Furthermore it is not possible to delay taking this annuity; the lack of flexibility and cut off date make pensions unstable and unreliable, but why should this be; the money is still there and without earning a penny would last some 19 years, the life expectancy at 65.
There is good reasons why in a pooled fund, as suggested in previous blogs, that rate fluctuations should be smoothed out and sustain a uniform pension regardless of retirement date and much higher, by a third on existing rates. The money can still earn income and in some schemes continue to grow after payments.
An alternative is Drawdown, which keeps the fund intact and earning whilst paying out a monthly income; this can also leave a residual sum for heirs. The money of course does not go as far and is subject to annual Revenue controls on withdrawal rate is costly to manage and only available for larger funds over £100,000.
More flexible annuity schemes are becoming available which allows contracts to be renewed every five years or so, with rates dependent on market conditions at renewal and residual funds available
The real answer is large stable funds well managed and secured in stable investments and investments will be dealt with in the next blog.
Savings Annuities Public Sector NHS Teachers Police Local Government Hutton State Pensions
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