There has been some debate lately in the trade press about the tendency of people to take level annuities rather than inflation-proofed annuities because of the higher amount available. This fact has been held up as proof of the need for advice at the point of retirement, because otherwise people will tend to take the larger amount on offer from level annuities and not factor in the consideration that inflation will erode the value of the annuity payments over time.
This view has been buttressed by research, which has indicated that most people feel they will die significantly earlier than statistics indicate; most of us do not appear to think we will be the lucky ones to hit the averages or even live longer. Therefore taking the money now appears to be the sensible option.
Irrespective of the length of our lives, there is one question that is being ignored by commentators and that is how much spending power is needed, as one grows older. All commentary assumes that people require the same lifestyle all the way through old age and that a gradually reducing income would therefore be a problem.
Is this true? Do people in their eighties have the same spending desires as people in their sixties? All evidence collected to date seems to indicate that this is not the case. As people grow older, their needs seem to reduce and far more eighty year olds save out of their pension than do those in their sixties. A German survey in the 1990s found that pensioners’ wealth declined as they moved into their 70s and drew down their income. Surprisingly, however, it began to climb again as they moved into their 80s because their spending levels dropped below their income levels. Statistics Canada found that Canadian pensioners in their 80s were managing to set aside 18.6% of their income.
Looked at from a common-sense point of view this makes perfect sense. We generally get more infirm as we get older and tend to travel less. There is also significant evidence that older people are less swayed by advertising and more cynical about the benefits of spending money on materiel things in terms of the extra value that spending would bring to their lifestyle. Therefore pensioners are less likely to replace a car that’s working just to have a more stylish model and they’ve usually become used to their house and furniture and don’t wish to undergo the stress of changing anything.
On this basis, getting higher income earlier from a level annuity and allowing it to decline with age is the perfect solution. Instinctively people are generally purchasing the correct income stream for their lifestyle and advisers who guide people to inflation-proof annuities may be doing their clients a big disservice.
Although financial education leads advisers to recommend inflation proofing, as declining income always sounds like a bad thing, maybe advisers have something to learn from the common-sense approach of pensioners themselves. They seem to recognise that their primary need will be for higher income in the early stages of their retirement but a declining need as time goes on. And we shouldn’t criticise them when they go for it.
Of course this could open up a whole new thought process in terms of getting government pension liabilities under control…but that’s a bigger issue and I’ll have to come back to it.
Are people better off with level annuities as opposed to inflation-proofed annuities? Let us know what you think in the comments below!