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New U.K. Annuity Reforms Are a Step Too Far

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After nearly a decade where the United Kingdom has been the gold standard for retirement savings policy, it is about to take a step that it may regret.

The U.K. has a retirement savings system that will enable virtually all of its workers to supplement their state-paid pension with retirement savings. When it is fully phased in, they will have access to a low-cost, diversified savings platform that uses automatic enrollment to encourage participation.

However, starting in April, the requirement that retirees convert 75 percent of their savings into an annuity that provides guaranteed lifetime income will be abolished. Government officials have encouraged savers to think of their pension as a bank account and to start to use it as early as age 55.

In theory, their new pension freedoms sound good. And there were serious problems with annuities that needed to be addressed — some charged unreasonably high fees or paid very low amounts of income.

American experience strongly suggests, however, that the U.K. is taking a step too far. Very few Americans buy annuities, feeling that they are spending a great deal of money for a comparatively small monthly income. Even those in traditional defined benefit pension plans usually take a lump sum if they are allowed to do so.

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Most people assume (often wrongly) that they can manage their own money as well as anyone else. Others greatly overestimate how long their savings will last. As a result, many of them spend unwisely, trust the wrong financial adviser or make other financial mistakes.

A recent study found that after 10 years in retirement, about 72 percent of those with pre-retirement incomes of up to $27,000 and 19 percent with incomes of up to $42,000 will be unable to meet their expenses. About 7 percent with incomes up to $65,000 and about 2 percent of those with higher incomes would also be in this category.

By the 20th year in retirement, more than 81 percent with incomes up to $27,000 would run short of money, as would 38 percent of those earning up to $42,000, and 19 percent of those with incomes up to $65,000. Even 8 percent of those with the highest incomes could not meet their expenses.

With rising lifespans, the U.K.’s proposal to let people spend their retirement money as they wish is a recipe for future problems. Even the requirement that free advice be available to all is not likely to be enough. U.S. experience shows that literally every minute that passes after general advice is given reduces the chance that consumers will act on it — even when they have decided to do so. And a significant number of those who consult with financial planners fail to act on that guidance.

The annuity horror stories in the British press show a definite need for change, but too many people are likely to run out of money under the coming reforms. A step back to some form of automatic guidance that nudges people towards having a certain level of guaranteed income or perhaps a longevity annuity that starts to pay income after a certain age would help British retirees to have a more secure future.

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