Report highlights potential benefit of switching to an annuity later in retirement

Pensioners in drawdown have been urged to consider revisiting their retirement decision part-way through retirement, as switching to annuity could be beneficial later in life.

The LCP report, Is there a ‘right time’ to buy an annuity, found that although someone aged 60 who chooses drawdown would initially be 10 per cent ‘happier’ overall than someone who immediately uses all of their pension pot to buy an annuity, annuities become more attractive later in retirement.

LCP’s model compared the happiness a retiree would get at each point in retirement from staying in drawdown compared with switching some or all of their savings into an annuity.

It looked at potential outcomes over a range of more than 2,000 different scenarios for future investment performance and life expectancy, taking into account factors such as attitude to risk and desire to leave an inheritance.

The model predicted that a typical retiree would be happier overall with an annuity at around age 67, and the attractiveness of an annuity grows the older they get.

LCP tested the model’s findings by varying the assumptions made about people’s preferences and found that all tests resulted in a ‘crossover point’ where annuities become more attractive.

For example, someone who is willing to take higher investment risk with a 75 per cent equity drawdown portfolio, the age at which switching to an annuity was likely to be beneficial was 70.

Meanwhile, if the individual is strongly risk-averse, they were urged to move out of drawdown at the age of 64.

LCP’s model found that a hybrid approach, where the individual uses part of their pot to annuitise at 60 and then annuitises the balance later in retirement, can generate the ‘best outcomes’ at all ages, with the crossover point where the balance of the pot is annuitised being approximately 71.

The report noted that annuities become steadily more attractive over time as the uncertainty of life expectancy grows as people get older, therefore it becomes harder to manage the balance of a pension pot in later life to make sure money does not run out or the individual does not live too frugally.

LCP stated that the findings show a mid-retirement MOT or drawdown products that default pensioners into an annuity at a later age could be beneficial.

“Whilst forcing people into annuities in their late 50s and 60s was not the right approach, it would be wrong to write off annuities altogether,” commented LCP partner and report co-author, Steve Webb.

“This powerful research shows that for a wide range of people there could come a point during retirement when a switch to an annuity gives them better outcomes overall.

“Policy makers need to think how best to nudge people to review their finances not just at retirement but during retirement.”

LCP partner and report co-author, Phil Boyle, added: “The exact point at which an annuity becomes more attractive depends very much on the individual.

“Our model suggests that for a wide range of people there is an age beyond which staying in drawdown may not generate the best results. As people get older, their life expectancy becomes more uncertain, and this creates a real headache for manging your pension pot. An annuity takes that uncertainty away.”

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