For staff saving in a defined contribution (DC) pension scheme, choosing the right annuity at retirement is critical.
This is the point at which the employee’s pension pot is at its largest and when they stand to lose the most, both from their own and their employer’s pension contributions, by making a poor decision or simply failing to act. Reaching retirement and purchasing an annuity is a one-off decision for the employee, so it is also irreversible if they get it wrong.
For many employees, shopping around to get the best annuity deal will result in a slightly higher income, perhaps a few hundred pounds a year. But over a typical retirement of 20-25 years, a few hundred pounds a year soon stacks up.
The greatest risks are when an employee either chooses the wrong type of annuity for their needs, for example if they don’t realise they have no inflation protection or accidentally fail to make any provision for their spouse, or if they get the wrong rate by failing to report lifestyle or medical conditions that could mean they are entitled to a much higher rate through an ‘enhanced’ or ‘impaired’ annuity. In some cases, an enhanced or impaired rate can boost income by 20-30% compared with a standard rate.
Providing employees with information and signposting them to websites that can help them shop around, for example the Money Advice Service, is helpful, but still leaves them to navigate their way through a complex and confusing market.
In the vast majority of cases, shopping around still requires staff to purchase an annuity through an adviser or broker.
Employers can play a key role here by taking steps to appoint an independent adviser or brokerage service for their DC pension plan that can actively guide employees through the process of buying an annuity. The NAPF will provide more guidance on the steps employers can take later this year.
Mel Duffield is head of research and strategic policy at the National Association of Pension Funds (NAPF)