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 die 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 an income drawdown 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
Income 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.