The extra cost of providing an income guarantee with a variable annuity is not worth paying for unless the investor actually needs it, says pensions specialist Steve Patterson.

‘Variable annuities’ is an American term for income drawdown products with guarantees; in the UK these have become known as ‘third way’ pensions.

But according to Steve Patterson, managing director of income drawdown specialist Intelligent Pensions, the problem is that, in many cases, the extra cost of providing the income guarantee is not worth paying for unless there is a need for it.

He says, ‘Typically, the cost of this “insurance” is around 0.75 to 1 per cent of the fund per annum, which doesn’t sound a lot, but over a 15-year period the remaining drawdown fund could be as much as 15 to 20 per cent lower, with a direct knock-on effect to the lifetime annuity thereafter.

‘I suspect that prospective investors may not fully appreciate the long-term impact when the benefits are being explained to them, and hope that the Financial Services Authority (FSA) keeps a close track on how these plans are being recommended.’

Whilst acknowledging that there is an argument that the inclusion of the underlying guarantee enables a higher degree of equity exposure than might otherwise be the case, Patterson points out that a well-run drawdown portfolio will include risk-management characteristics that will allow an appropriate degree of equity exposure already.

‘“Third way” products definitely have their place, and we will recommend them where appropriate,’ says Patterson, ‘but the product providers in this space will be the first to agree they are certainly not a cure-all for the “at retirement” market.’