...by my company and others.

I'm going to provide some brief background on the UK market. I will then discuss why I believe most pensioners need an annuity and when pensioners should annuitize. Then I'll provide some comments on investment considerations. Finally, I'll attempt to suggest that although the United Kingdom and United States currently have very different approaches to converting savings into retirement income, there are signs of both countries beginning journeys based on customer needs which may well converge in the future.

It might help if I define what I mean by annuitization up front. By annuitization I mean that people enter an annuity pool in which they put their capital at stake in exchange for an enhanced income for life. This contrasts with a drawdown approach in which they draw income from their pension fund and if they die their outstanding fund less some tax is available as an inheritance. In the United States, I believe this would be the equivalent of systematic withdrawals.

UK RETIREMENT INCOME MARKET 2005

The UK pensions system was significantly simplified in April 2006 with one set of rules combining both defined contribution and defined benefit schemes. Essentially the UK government gives generous and flexible tax relief that allows people to build a pension fund up to a lifetime allowance of 1.5 million [pounds sterling] (close to 2.5M US dollars). In practice, the current average DC fund in the United Kingdom is less than 30k [pounds sterling] at retirement.

At retirement, UK pensioners can take 25 percent of their fund as a tax-free cash sum with the remaining fund used to provide regular retirement income through an annuity or drawdown account. Broadly, withdrawals in any year up to age 75 cannot exceed 120 percent of sustainable lifetime income. There are still strong incentives to buy an annuity by age 75. Prior to April 2006, the purchase of an annuity by age 75 was mandatory in the United Kingdom. The UK government's philosophy is that pensions savings should be used to secure a pension, not to provide an inheritance scheme.

If we look at the UK market (see Figure 1) it is essentially polarized in two corners; in the bottom left hand corner are fixed annuities and in the top right corner is income drawdown.

[FIGURE 1 OMITTED]

With fixed annuities, the annuitant gets certainty with respect to investment and longevity with a guaranteed income for life. With income drawdown, the pensioner takes the investment risk and, although he or she may not appreciate it, considerable longevity risk, but the plan gives a return of fund on death.

There is currently very little in the middle ground. There are a few contracts where the investment risk and longevity risk are shared with the pensioner, but these products account for less than 2 percent of the UK market. If you think about it, this is not consistent with a normal market. You would normally expect the majority of business to be in the middle ground with the more adventurous pensioners buying in the top right corner and the more cautious in the bottom left.

US RETIREMENT INCOME MARKET

From what I have been able to gather the US market is also polarized (see Figure 2). This time with most of the retirement income coming from systematic withdrawals from pension funds with limited use...

NOTE: All illustrations and photos have been removed from this article.




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