Annuities have always been a serious business* but since the introduction of pension freedoms in 2015 most retirees (and advisers) have not taken annuities seriously and many invested in pension drawdown rather than purchase an annuity.
Annuities have been unpopular for three reasons:
- The income from annuities has been very low
- Annuities have no flexibility so the alternatives appear more attractive
- On death, there may not be anything to leave to the family
I have been advising clients about their annuity options for over 25 years and I too have not taken annuities seriously for the last 10 years because since the credit crunch in 2008 rates have been so low, but I really believe that it is time to take annuities seriously again.
Three things have happened in 2022 to make annuities more attractive:
- The income from annuities has increased significantly
- Recent stock market falls have made pension drawdown less attractive
- In an uncertain world many more people want peace of mind and financial security
Before I explain why annuities should be back in fashion it will be helpful to recap on some basic retirement income principals.
When it is time to convert a pension pot into a regular income (after the age of 55 and probably after taking the 25% tax-free cash) there are basically two ways of doing this:
- An annuity policy – exchanging the pension pot for guaranteed income for life
- A pension drawdown plan – taking regular or ad hoc income withdrawals directly from the pension pot
I use the term ‘annuity policy’ because an annuity can be thought of as a type of insurance policy which guarantees income for life. Pension drawdown is simply the option to keep investing in the stock market and to take income direct from the fund.
This means that an annuity pays a guaranteed income no matter how long the annuitant lives whereas with pension drawdown the income is not guaranteed and it is possible to run out of income.
These explanations may be simple, but the decision whether to purchase an annuity or invest in pension drawdown is one of the most difficult personal finance decisions, especially now interest rates are higher and the stock market is more volatile.
Why annuities should be taken seriously
The short answer is now (July 2020) annuity rates have risen to a level that makes them much better value than at any time in recent years. This not only means that annuitants can get a higher income now but, in many cases, especially where peace of mind and financial security are important, annuities may be a better option than pension drawdown.
A longer answer is that annuities are the only policy that can pay a guaranteed income from life no matter how long that is. Once people realise they cannot have their cake and eat it; that is have high income, flexibility and leave money to the family all in one plan, the option to maximise lifetime income becomes more attractive.
At the heart of the decision about annuities or drawdown are a number of important trade-offs. For instance, maximising lifetime income or leaving an inheritance, flexibility or guaranteed income and low risk versus higher risk.
It is easy to frame the discussion as a choice between a poor value and inflexible annuity and a better value, flexible and potential to leave an inheritance drawdown, but this is to oversimplify the matter and risks encouraging people to take more risk than they should take and to potentially to have a lower lifetime income.
When rates were lower, the alternatives to annuities such as pension drawdown seemed more attractive, but now annuity rates are high they are once again a hard act to beat and, in many cases, may be a better option than pension drawdown.
Annuities give peace of mind and financial security and this is something everyone in retirement wants – even if they can’t properly articulate it.
“An annuity is a very serious business; it comes over and over every year, and there is no getting rid of it”. Jane Austen in Sense and Sensibility.
Annuity Update
| What’s happening to annuities? – Annuity rates have increased significantly this year.
Why are rates rising? – Bond yields have doubled since January How much have rates increased? – So far this year the income from a £ 100,000 annuity has increased by £1,300 per annum which is 35% |
Annuities rates are linked to the yields on fixed interest investments such as gilts and corporate bonds. In January 2022 the yield on 15-year gilts was 1.25% and the £100,000 benchmark annuity paid an annual income just below £ 4,000 before tax.
In July 2022 the gilt yield rose to 2.5% and the benchmark annuity increased by nearly 35% to £5,300 per annum.
Latest trends
| Jul 2022 | Jun 2022 | Jul 2021 | |||
| This month | Last month | change | 12 months | change | |
| Benchmark annuity1 | £5,312 | £4,930 | 7.75% | £4,100 | 29.56% |
| Gilt yield2 | 2.58% | 2.39% | 1.10% | ||
| FTSE 100 | £7,168 | £7,532 | -4.83% | £7,125 | 0.60% |
1Annuity income – Ages 65 and 60, £100,000 purchase, joint life 2/3rds and level payments
215 Year gilt yield taken from FT
Annuities can be good value
My main criticism of annuities when rates where rock bottom was that annuities just about re-paid the original capital with very little interest. Now that rates have increased the underlying rate of return is about 3%.
Put it another way, if you don’t purchase an annuity but take the same income from drawdown, you will need an underlying rate of return of at least 3% (after charges) plus a bit extra to compensate for the lack of mortality cross subsidy
With so such uncertainty and volatility in the global stock markets and at times, negative returns, achieving steady growth while investing in a drawdown plan is difficult.
This means that if you want to maximise your income in retirement, annuities now seem a better bet than drawdown for those with modest pension pots.
Also, many people underestimate their life expectancy. For example, a 65-year-old man can expect to live another 20 years to age 85 whereas a lady of the same age can expect to live to age 87 according to the Life expectancy calculator from Office for National Statistics.
Annuities do something that pension drawdown cannot do and that is guarantee that you will not out live your income. With drawdown you can run out of money but annuities continuing paying income for the rest of your life.
Two popular questions
The two most popular questions from clients are; “when will annuity rates go up?” and “when is the best time to purchase an annuity?”.
The answer to the first question is that annuity rates should continue increasing as inflation stays high and yields will continue to increase
The best time is when you need to secure guaranteed income – ideally you can look for the time when funds value are high and annuity rates good value but that is difficult to predict.
Emotionally, ask yourself “when do you want more peace of mind and security with your retirement income?”
The author – Billy Burrows
William (Billy) Burrows, is founder of the Retirement Planning Project and a financial adviser at Eadon & Co.
The project aims to make it easier for people to get information and help and on all aspects of retirement planning. The project will also make it easier for people to access financial advice.
Billy advises individual clients and members of workplace pension schemes on all aspects of retirement options and specialises in advising on annuities and pension drawdown.
In 2018 Spire Platform Solutions did a lot of customer research into what people liked and didn’t like about annuities. Customers strongly dislike the fact that you absolutely cannot surrender a conventional annuity. Although interestingly, they regarded the likelihood that they actually would surrender as being very low. This apparent paradox can be solved by adding a surrender facility to an annuity-like product.
@adrian
It could be an answer.
I think the main problem for annuities is inflation.
When we run inflation at 8%, expected to reach 10%, and the new Prime minister would like to go on a spending spree and cut taxes, I am not convinced inflation would be low in this country.
The above examples in the blog are level annuities. Those money could easily become worthless!
Interesting piece.
It could also have mentioned the UFLPLS option as an alternative to drawdown where a series of lump sums can be taken but with the tax-free element spread. this can help with tax planning and keeps all options available.
Annuities have lots of options too don’t forget which can make them more attractive for certain people or their objectives. Someone with a medical condition/history for example could get an enhanced annuity, and/or use the capital protection/guarantee period/fixed term option to leave a potential inheritance.
Life expectancies are rarely quoted in the media as being an average. A good proportion of people will live longer, sometimes significantly longer, than the averages quoted. I believe IFAs/planners will often use 95 as an estimate of the age at death in order to reflect that.
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