It is crucial that intermediaries assist pensioners with annuity options

How should the laypersons choose between investment-linked annuities, living annuities and guaranteed annuities? As financial advisers it is our responsibility to communicate the choices to individuals in such a way that they are able to make an informed decision.

Roy Stephenson, Annuity Actuary at Old Mutual Corporate believes that pensioners are often not fully aware of the risks and consequences involved in selecting an annuity. He says the retirement industry needs to take responsibility for educating pensioners on all of the potential implications of their choices upon retirement.

Essentially, pensioners must choose between an investment-linked annuity and a guaranteed annuity. This decision is not always as clear cut to the pensioner as one may think, and the only way the pensioner can take an informed decision is if they truly grasp and understand all the information.

Investment-linked annuities enable pensioners to share in the investment returns made on the underlying annuity portfolio by way of annual increases to their pensions and can be very effective in helping pensioners combat the negative effects of inflation. "The broker needs to demonstrate the value of this solution given volatile market conditions, especially with inflation creeping towards the upper margins of the 3% to 6% band,” says Stephenson.

At the other extreme, there are those members who opt for a living annuity at retirement. Clients must be informed how this annuity type works. "With a living annuity, the individual decides on the level of income they need to draw down every year from an investment fund chosen based on their risk appetite. In this case, members take on the risk of potentially exhausting their savings pool before death. This is not a concept that is easily visualised by the average pensioner,” says Stephenson. He observes that real life, numerical case studies may be very useful in explaining the concept.

The living versus guaranteed annuities debate is as ongoing one, but most pensioners will not be aware of the details and it would be dangerous to assume so. Pensioners must be educated that guaranteed annuities can include both level annuities and CPI (inflation) guaranteed annuities – and that each option is suitable under different circumstances. "Living annuities are suitable for the financially aware who have considerable funds while guaranteed annuities are better for those less financially aware who have limited funds,” he concludes.

Stephenson says brokers must be aware that living annuities have, in the opinion of some, been oversold. It appears that individuals with limited capital have been sold the product, perhaps driven by advisers who receive better "trail” commission on them.

"As markets have performed badly, these pots of money are running low earlier than expected and people may unexpectedly have insufficient funds left to live off. This has the potential to create major hardships in the pensioner market – and one must be sensitive to this,” notes Stephenson.

Guaranteed annuities have also fallen out of favour because of low interest rates (and therefore lower pensions) and the fact that there is no residual capital amount to leave to your heirs upon death. Given the trend of people living longer and the increased risk of outliving assets in retirement, the protection offered by a guaranteed annuity cannot be overlooked.

An understanding of the issues affecting pensioners will enable intermediaries to identify closely with their clients and provide them with the information they require to make an informed, rational retirement decision.