Mortality Drag
Mortality drag is a term used alongside
pension drawdown contracts. It can be
represented by the additional investment return
required to overcome the effect of life
expectancy increasing as we get older and the
expense that this creates if you delay buying an
annuity.
Why does life expectancy increase as we get
older?
It is a sad fact that some people do not live as
long as others; ill health, accidents and
suicide contribute to this. If the average life
expectancy of newborns is, say 77 then it become
apparent that as we get older and some people
die then the average age for those that remain
alive must increase. For example, if 10,000
people make it to age 100 then the average life
expectancy for those people must be greater than
100.
Pricing of annuities
Annuity providers understand that some of their
annuitants will not live as long as others. The
savings they make from not having to pay annuity
income to those people is used to cross
subsidise the cost of those that live longer
than expected. In effect, the annuity provider
prices their annuities according to the average
life expectancy of their annuity pool.
Why is an annuity more expensive, relatively,
if purchase is delayed?
As outline above, people that dies younger than
expected cross subsidise those that live longer.
If you delay buying an annuity then some of that
cross subsidy will be lost as a result of some
people having died during the period that the
annuity purchase was delayed.
How much does mortality drag actually cost
Annuity providers have different pricing
structures from time to time so an exact cost
cannot be calculated. However, the FSA estimates
that the investment return required from a
drawdown contract may need to increase from 5%
to 5.47%pa. We have produced a
calculator which calculates the maximum
income that can be paid from a drawdown pension
and overlaid this with investment returns to
show how much income you can expect to receive
over a period of time compared to a traditional
annuity.Before choosing drawdown
Drawdown can be very good way of taking income
in retirement for those that understand the
risks associated with it. Use our
drawdown comparison calculator to help you
decide if it is right for you and always seek
professional advice - we are here to help.
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