ARFs should not be permitted for AE pensioners

[Duke of Marmalade]

Post 1
What has prompted me to this conclusion is the debate on lifestyling. Lifestyling seems to have bifurcated into the target annuity or the target ARF camps (ignoring the tax free lump sum for this thread).
This is a major bifurcation which has come into sharp focus with recent rises in long yields. Annuity lifestyling has led to 20% falls in retirement funds whilst ARF lifestyling has moved sideways.
As 95% of Auto Enrolment (AE) contributors will be defaulted into a lifestyle fund it is a huge question - which type? This, like many other aspects of drawdown, have been put on the long finger.
My solution - the annuity option should be compulsory;
That sorts out the lifestyling conundrum. But that is not my main reason.
Wind back 30 years. All tax subsidised supplementary pensions had to be taken in the form of an annuity. Then Charlie McCreevey launched his revolution. He argued that the compulsory annuity was ridiculously paternalistic - this was the retiree's own money. And the ARF was born and the UK has latterly sort of followed us. But this was for the self employed - a constituency supposedly more able to manage large sums of money. Even Charlie baulked at occupational pension fund members having that freedom. To this day that restriction still applies and of course public servants must take an annuity - though that would be partly driven by government finance considerations.
Now if occupational pension fund members need this paternalistic protection how much more must this be the case for the target audience for AE?

 

[Duke of Marmalade]

Post 2
So AE retirees should be compelled to invest their retirement fund in an annuity. (Of course after taking the tax free lump sum).
Annuities are bad value, I hear you shout. I am suggesting State annuities but only for AE retirees.
State annuities would be much more attractive than commercial annuities for the following reasons:
1) Cost of administration minimised because of scale and leveraging off other competencies such as in Revenue, after all they are well able to process the basic State pension, no problem with "evidence of existence" for example.
2) No commission, of course
3) Most important, I do not think they should be costed to provide for the cost of capital to back such things as 1 in 200 longevity improvements or inflation outcomes.
4) They would not be hidebound to artificial QE induced market yields as has been the case in recent years.
And they would have access to a welter of relevant demographic data to do the actuarial pricing. It is possible that for some people, say impaired lives, the market can offer better value and that option would be open to the retiree.

A secondary beneficial effect would be that this would be a source of funding for the National Debt.

 

[T McGibney]

Even Charlie baulked at occupational pension fund members having that freedom.

No, he didn't baulk at that suggestion at all but conceded that particular point to get his ARF idea over the line in the face of civil service and life industry objections.

 

[Duke of Marmalade]

No, he didn't baulk at that suggestion at all but conceded that particular point to get his ARF idea over the line in the face of civil service and life industry objections.

I was in the room when Charlie came to the IIF* offices to argue for his revolutionary proposal. You are right that he would have wanted the freedom for everyone but he did argue that self employed folk in particular would be well able to handle the financial responsibility of managing their own retirement fund.
My recollection is that the industry were very skeptical. I don't think this was down to self interest as ARFs have surely benefitted the industry.
* Irish Insurance Federation

 

[Steven Barrett]

Post 1
What has prompted me to this conclusion is the debate on lifestyling. Lifestyling seems to have bifurcated into the target annuity or the target ARF camps (ignoring the tax free lump sum for this thread).
This is a major bifurcation which has come into sharp focus with recent rises in long yields. Annuity lifestyling has led to 20% falls in retirement funds whilst ARF lifestyling has moved sideways.
As 95% of Auto Enrolment (AE) contributors will be defaulted into a lifestyle fund it is a huge question - which type? This, like many other aspects of drawdown, have been put on the long finger.
My solution - the annuity option should be compulsory;
That sorts out the lifestyling conundrum. But that is not my main reason.
Wind back 30 years. All tax subsidised supplementary pensions had to be taken in the form of an annuity. Then Charlie McCreevey launched his revolution. He argued that the compulsory annuity was ridiculously paternalistic - this was the retiree's own money. And the ARF was born and the UK has latterly sort of followed us. But this was for the self employed - a constituency supposedly more able to manage large sums of money. Even Charlie baulked at occupational pension fund members having that freedom. To this day that restriction still applies and of course public servants must take an annuity - though that would be partly driven by government finance considerations.
Now if occupational pension fund members need this paternalistic protection how much more must this be the case for the target audience for AE?

No it doesn't. The ARF is available to all DC pensions. Even members of DB pensions can take a transfer value from their pension and then ARF that. The only people it doesn't apply to it public service pensions because it is unfunded.

 

[Duke of Marmalade]

No it doesn't. The ARF is available to all DC pensions. Even members of DB pensions can take a transfer value from their pension and then ARF that. The only people it doesn't apply to it public service pensions because it is unfunded.

Yes Steven I am aware that the outright ban can be got around these days. As a DB pensioner myself I must stick with my pension and my recollection is that if I wanted an ARF I would have had to go through some artificial hoops such as being temporarily a deferred pensioner.
My point is that the origins of State supported supplementary pensions are steeped in the concept that it is a pension that you are funding for, not a retirement pot. Those origins have to a considerable extent been diluted both here and in the UK but the rationale, paternalistic or simply to prevent the State having to bail out irresponsible folk, still remains and especially so for the AE constituency.
And of course there is no question of commuting your contributory State pension. AE should really be viewed as a second tier quasi State pension. DB would be best but that has been firmly rejected at Government level but the extreme of an ARF option is going too far IMHO.
When I explain to people that the new DC world is leading people on ordinary incomes to have large 6 or maybe 7 figure sums to manage in retirement, they don't believe me.

 

[T McGibney]

My recollection is that the industry were very skeptical. I don't think this was down to self interest as ARFs have surely benefitted the industry.
* Irish Insurance Federation

The late great tax consultant Frank Brennan used claim that this was on foot of fear on their part that retiring ARF holders would all be wanting to buy themselves Harley Davidsons.

 

[Duke of Marmalade]

The late great tax consultant Frank Brennan used claim that this was on foot of fear on their part that retiring ARF holders would all be wanting to buy themselves Harley Davidsons.

Charlie teased the assembled IIF executives "do you think this will lead to pensioners going off with Hula dancing girls in the South Sea islands?"

 

[JimmyB99]

I was in the room when Charlie came to the IIF*

Well you may remember where you were, but you certainly don't remember when you were there! The bold Charlie wasn't even Minister for Finance until 1997 and it was another 2 years before ARFs were introduced.

Upon its introduction, Charlie told members of the pensions' industry to get a grip. The then chairman of the IAPF got the hump big time. https://www.irishtimes.com/business/mccreevy-changes-could-impoverish-pensioners-iapf-1.157135

Looking back, McCreevey definitely made the right call. I wonder what O'Faherty would say now (he is a reasonable man).

Anyway, I really don't like it when falls in an annuity fund are not explained in full - i.e. without mentioning the inevitable improvement in annuity rates that will to a large part insulate (or potentially even more than compensate) any such falls.

 

[Allpartied]

Post 2
So AE retirees should be compelled to invest their retirement fund in an annuity. (Of course after taking the tax free lump sum).
Annuities are bad value, I hear you shout. I am suggesting State annuities but only for AE retirees.
State annuities would be much more attractive than commercial annuities for the following reasons:
1) Cost of administration minimised because of scale and leveraging off other competencies such as in Revenue
2) No commission, of course
3) Most important, I do not think they should be costed to provide for the cost of capital to back such things as 1 in 200 longevity improvements or inflation outcomes.
4) They would not be hidebound to artificial QE induced market yields as has been the case in recent years.
And they would have access to a welter of relevant demographic data to do the actuarial pricing. It is possible that for some people, say impaired lives, the market can offer better value and that option would be open to the retiree.

A secondary beneficial effect would be that this would be a source of funding for the National Debt.

Why not just make this an option?
In other words give people a choice, between a well run, stable annuity, state guaranteed, with minimal charges.
And an expensive rollercoaster in the stock market.

There may be occasions when using an ARF makes sense, but lets give people the choice.

 

[Duke of Marmalade]

Well you may remember where you were, but you certainly don't remember when you were there!

I don't know whether you are being flippant (which is fine) or think you are making a serious point (which isn't fine).

 

[Duke of Marmalade]

Why not just make this an option?
In other words give people a choice, between a well run, stable annuity, state guaranteed, with minimal charges.
And an expensive rollercoaster in the stock market.

There may be occasions when using an ARF makes sense, but lets give people the choice.

It looks like shaping up to be a choice between a commercial annuity and an ARF. Yes Post 2 of my OP is relevant to this as you suggest. It would still leave us with how do you lifestyle the 95% who will give no indication of what they want? Though I admit we should not let lifestyling be the tail that wags the dog.
Post 1 is making the more radical suggestion that AE should be on a par with the basic State pension - strictly a pension with no ARF or commutation alternative. If some folk don't want this and there may be many in the higher income bracket we have a vibrant commercial industry to serve them.
Also no Transfer Values just like the basic State pension.

 

[Colm Fagan]

@Duke of Marmalade . You're right that the current lifestyling debacle is causing a lot of soul-searching in the industry - and lots of concern among insurance executives. It's also reinforcing my belief that the smoothed approach to AE is the only way forward.
Firstly, the debacle? Over the last 12 months or so, some lifestyle funds have fallen 20% or more, despite members having been often (invariably?) reassured that the purpose of lifestyling was to protect them from falling markets. Why have they fallen so much? Because they were invested heavily in long bonds, whose value fell when interest rates rose. With the lower retirement proceeds, retirees could buy much the same annuity as they could have bought when interest rates were lower and fund values higher. All hunky dory if they were planning to buy an annuity, but what if they weren't? A lot of insurance companies - and their auditors, and maybe even the regulator - are now examining sales and marketing material, and formal documentation, for such products, to ascertain possible exposure to mis-selling claims. I'll be very surprised if there isn't significant industry exposure to the risk, a risk that they didn't even know existed only a short time ago.
Now to AE (auto-enrolment).
The DSP has promised that default AE funds will adopt lifestyle investing, but it's highly unlikely that they ever thought through the implications of that bland statement. Did they mean transferring into bonds in the lead-in to retirement or into cash? It's as sure as night follows day that it never crossed their minds. It will now - and will result in another bout of soul-searching before they come to a conclusion. More time wasted.
The Duke says that annuities should be compulsory for AE, implying that lifestyling should target long bonds. However, as Tim Duggan of the DSP rightly says, it will be years before AE proceeds are big enough to justify annuitisation. Therefore, the asset mix at retirement for default funds should change over time - targeting cash for the first (say) ten years or so of the scheme's existence, then gradually shifting to bonds, but making sure to tell members that moving to bonds could leave them exposed to the risk of sharp falls in the value of their pots if interest rates rise close to retirement. It's all very confusing, and knowing the speed at which government works, it will take years to resolve satisfactorily.
Personally, as a "retiree" of more than ten years' standing, I wouldn't touch annuities with a barge-pole. Neither am I recommending them for AE in my smoothed proposals, a summary of which can be found in my presentation to the TASC seminar earlier this week (slide 12):
https://www.tasc.ie/assets/files/pd...heme_colm_fagan_tasc_event__28_march_2023.pdf
There are a number of reasons for not recommending annuities, ever.
Very few in their right mind, having saved for a lifetime, would willingly part with those hard-earned savings at retirement in return for the promise of an income for life knowing that, if they fell under a bus the next day, their savings would disappear down the plughole. OK, I know that they can buy guaranteed annuities, etc., but they just ease the pain.
There's also the risk of inflation. I recall being a pension consultant in the early 1980's (yes, I'm that ancient!) and advising a company secretary that he should consider giving increases to pensions in payment for workers who'd retired three years previously, because of the rampant inflation at the time. He looked at me and said: "Colm, do you know that we have pensioners in this company who haven't got an increase since 1967? They'll have to get something before any of your pensioners get anything". That stopped me in my tracks: inflation between 1967 and 1980 was probably over 150%. Never again did I recommend annuities. Who's to say that we won't get spells of high inflation again in future?
Under my proposal, members' funds (including those for retired members) are invested 100% in real assets, so the amounts that retired members can draw down should broadly follow inflation in the long-term.
Annuities are completely inflexible. I can vary what I withdraw from my ARF (within limits) to deal with changes in outgoings from year to year. I want AE pensioners to enjoy similar flexibility. See slide 12 of the presentation referred to above.
DSP has said that "innovative solutions" can be welded on to their current AE proposals at some future date. I have compared it to adding brakes to a car when it's on the road. One thing the current lifestyle debacle has taught us is that it's deadly dangerous to try to weld a post-retirement solution onto a pre-retirement product that operates completely independently. The transition from pre- to post-retirement must be absolutely seamless. The smoothed proposals achieve that seamlessness.

 

[Steven Barrett]

The late great tax consultant Frank Brennan used claim that this was on foot of fear on their part that retiring ARF holders would all be wanting to buy themselves Harley Davidsons.

That was the reason given for the imposition of the AMRF. When what it really did is stop terminally ill people and those with small pension pots from being able to access their own money. The wealthy thought it was great at there was no imputed distribution on them.

 

[Duke of Marmalade]

@Colm Fagan You know I am being slightly Devil's Advocate here. I am seeing AE as in effect a supplementary quasi State pension (State not quite on the hook but let's not go down that rabbit hole). It should be compared with the first tier - the Basic State Pension. The BSP is not for commuting and is quasi inflation linked. That is what my suggested State annuity would be, albeit commercially based.
As for folk feeling cheated by an annuity if they die prematurely that seems to be a matter of optics. Take a DB retiree who gets hit by a bus on the way home from the retirement party. The first thing she will say to St Peter is "contributed to a pension for 47 years and they pocket every single cent of it, I wonder did they pay that bus driver:mad:".
On a serious note, I understand that your proposal does include a longevity pooling feature which is still 100% equity based. The fact that your proposal requires no investment decisions or lifestyling for the punter together with the longevity protection option would certainly trump my compulsory annuity suggestion.

 

[Brendan Burgess]

Duke



1) I like the idea of telling people emerging from an AE scheme that they can't have all their cash immediately and then become dependent on the state if they blow it - or give it to their kids to get on the housing ladder.

2) I don't like the idea of buying a traditional annuity which is effectively investing in bonds

3) I do like the idea of some risk sharing - for every Colm that falls under a bus on the way home from the retirement party, there will be a Brendan who lives until 110 who benefits from Colm's early demise.

Some version of a smoothed equity fund, e.g. Colm's proposal, would be the ideal solution.

Brendan

 

[Robzig]

I recall being a pension consultant in the early 1980's (yes, I'm that ancient!) and advising a company secretary that he should consider giving increases to pensions in payment for workers who'd retired three years previously, because of the rampant inflation at the time. He looked at me and said: "Colm, do you know that we have pensioners in this company who haven't got an increase since 1967? They'll have to get something before any of your pensioners get anything". That stopped me in my tracks: inflation between 1967 and 1980 was probably over 150%. Never again did I recommend annuities.

Hi Colm,

There's one part to this story that I don't understand. Why did you only want recent pensioners to get an increase?

 

[Colm Fagan]

I am seeing AE as in effect a supplementary quasi State pension (

I do like the idea of some risk sharing - for every Colm that falls under a bus on the way home from the retirement party, there will be a Brendan who lives until 110 who benefits from Colm's early demise.

Duke, I too like to view AE as an extension of the State pension, which is partly why my original proposal (in 2018) had no commutation whatsoever, the argument being that commutation offends against the principle of tax relief on the way in, tax on the way out, but I was advised (rightly) that it was a step too far. Subsequent iterations fixed the commutation percentage at 25% (possibly to a max of 1.5 times earnings).

Brendan, I agree with the idea of risk sharing, but there's a limit! In your example, I'd have no problem being a Brendan, but I'd have a big problem being a Colm. The solution in the paper satisfies both the Colm's and the Brendan's of this world. Longevity protection starts at 75 (normal drawdown applies until then) at which point the account is divided into 15 identical subaccounts. Colm dies at 76, so he'll have claimed just one of his subaccounts, but his family get the other 14. Brendan, having lived to 110, gets 15 subaccounts between 75 and 90, but then gets another "bonus" subaccount each year for the next 20 years until he's 110, so he does fantastically well. Who pays for Brendan's bonus subaccounts? Not Colm, because while he got just one of the 15 subaccounts from age 75, his family got the other 14.
The Duke is the fall guy! He lives precisely to age 90, taking one subaccount each year before cocking his clogs the minute he's taken the last subaccount. Ok, you'll say, he's got all his 15 subaccounts from age 75, as have the other two (or his estate, in Colm's case). However, transfers to the subaccounts from age 75 get a lower rate interest rate (2.45% a year lower than money in the "normal" smoothed account, I'm suggesting). Colm only suffers the lower interest rate for a year. Brendan suffers it for 15 years but, in return, he gets a bonus subaccount every year for 20 years, so he's a big winner. The poor Duke, though, suffers the 2.45% interest deduction for 15 years but gets nothing for it, because he dies just before the bonus subaccounts kick in.

 

[Colm Fagan]

There's one part to this story that I don't understand. Why did you only want recent pensioners to get an increase?

Good question, which I should have answered at the start. Sorry.
The answer is that I was advising the company on one particular scheme. I didn't know they had other pension schemes. (The Group had a number of subsidiaries, each with different pension arrangements and different consultants advising on the different schemes).
Does that answer your question?

 

[Robzig]

That makes sense now, thanks.