Another critical issue is the longevity insurance strategy. It is essential for ensuring the pension scheme serves its primary purpose of providing a lifelong income. But when should longevity insurance be purchased and when should it come into effect?
This essentially boils down to the choice between buying an immediate annuity when it is needed, and buying a deferred annuity at the point of retirement, with the deferred annuity beginning to make payments when it is needed. Most experts believe that for a normally healthy individual, longevity insurance should come into effect some time between age 75 and 80.
Charges for drawdown vary considerably and in total could have up to four components: the charge imposed by the scheme provider to cover operational costs (such as administration), the investment management charge, the platform charge (0.25 per cent to 0.50 per cent a year), and the charge for advice (0.50 per cent to 0.75 per cent a year). Even for a simple fund structure from a low-cost provider, the annual charge might be 1 per cent, plus an administration fee of £250 a year (to cover the cost of income payments and income amount reviews). A more common total cost is about 2 per cent a year. High charges can be as lethal as poor investment performance in reducing the value of the pension pot over time.
So we are still a long way from pension freedom being the long-term success everyone wants. We do not yet have companies offering a low-cost, well-designed scheme drawdown that delivers flexible access, inflation protection and longevity insurance. We do not have a well-developed deferred annuity market. Indeed, we do not have any safe-harbour products. Instead, too many people face the prospect of investing in unsuitable high-risk, high-cost products that could well run out of money before they die.
| Median contribution rates into pension arrangements provided by responding employers | ||
| Type | Employer | Employee |
| Group personal pension | 4% (5.8%) | 3% (4.2%) |
| Trust-based DC | 5% (6.9%) | 4% (4.5%) |
| Nest | 1% (NA) | 1% (NA) |
| Other multi-employer schemes | 3% (NA) | 1% (NA) |
| Mixed DB/DC | 11-15% (NA) | 5% (NA) |
| DB | 16-20% (21.9%) | 6% (NA) |
| Note: Figures in brackets are 2013 mean figuresSource: ACA (2013) Pensions Trends Survey Report | ||
David Blake is professor of pension economics at the Pensions Institute of Cass Business School
Key points
Along with the benefits of pension freedom come the risks, including the investment risk associated with big falls in the stock market index.
An alternative to drawdown sold in the retail market is scheme drawdown.
Another critical issue is the longevity insurance strategy.
