Is an annuity a pension?

Henry Tapper, for those who don’t know him, is probably the most influential commentator and thinker about pensions and writes an influential blog called AgeWage: Making your money work as hard as you do | "one of ten websites and blogs every investor should bookmark"- The Times.

In a blog today, Why do people look forwards to pensions but not annuities? he started an interesting conversation about whether an annuity is a pension.

Henry clearly does not think so, but as with many things, the question and answer are more nuanced.

From my understanding, Henry’s gripe is with his pension provider referring to an annuity as being a pension as set out in the following paragraph – “You ask what I want for my DC pension pot and for my DB pension which I get from a very good former employer. The answer is simple- I want a pension and not an annuity and I don't want confusion with the phrase "pension annuity" which is being promoted to me by my personal pension plan provider - L&G.”

Perhaps I am missing the point, but an annuity is a pension. However, it is not just a play on words but I think we can say that a pension plan does not have to result in an annuity, but an annuity is a pension.

In my defence, I refer to two important points:

• What actually is a pension?
• What do many people really want in terms of retirement income?

What actually is a pension?

Interestingly, the Government website says “Private pension schemes are ways for you or your employer to save money for later in your life.” This is interesting because it does not refer to a pension as being an income in retirement.

However, the Cambridge Dictionary defines a pension as “a sum of money paid regularly to a person who has retired (= stopped working because of having reached a certain age)”. While Wikipedia writes - A pension (from Latin pensiō 'payment') is a fund into which amounts are paid regularly during an individual's working career, and from which periodic payments are made to support the person's retirement from work.

My view is that a pension is a regular income throughout retirement but a pension scheme / plan is a thing of two halves: the saving half and the payout half.

let’s call this a score draw! We are both right because the definition of a pension is elastic - a pension does not have to be an annuity, but an annuity is a pension.

What do many people really want in terms of retirement income?

The quick answer is that many people don’t actually know when they first retire so many want their cake and eat: a regular secure income but flexibility and control and the option to leave money to their family after their death.

A deeper analysis suggests that people are faced with a choice between maximising lifetime income without taking undue risks and having the flexibility and control over how they take cash and income from their pensions. The former is an annuity and the latter is pension drawdown.

In terms of the debate about annuities, the mistake is to think that pension drawdown maximises retirement income. It might do, but there is a real risk that it will not provide the same amount of income as an annuity, especially at time of relatively high bond yields.

I look at the matter in a different way. As an adviser, I have an open mind about whether annuities are better than drawdown. We simply don’t know and it all depends on future investment returns and personal circumstances. As an adviser, I focus on objectives: what do clients what to and achieve in retirement and how much risk do they want / can take?

Often the matter is brought into sharp focus when I say: “I don’t want to put words into your mouth but you are probably looking for:

• A sustainable income for the rest of your, and your partner’s life
• To keep pace with inflation
• Without taking undue risks
• With as much flexibility and control as is prudent

When you unpack this, this is neither an annuity (because there is no flexibility or control) or drawdown (because it is not necessarily sustainable income without taking undue risks), it is a combination of each option. This combination may change over time and a prudent person will derisk (annuitize) as they get older.

So, in the final analysis, an annuity is a pension, but people don’t have to have all their pension eggs in one basket.