Annuities – a thing of the past or the road to a certain financial future?
Annuities. A throwback to a bygone era, right? Something that went out with VHS recorders, travellers’ cheques and shell suits? Well…, not quite. If Mark Twain was around today he would question whether reports of the death of the annuity have been greatly exaggerated.
So what is an annuity?
Simply put, an annuity allows you to swap your pension pot (or some part of it) for a guaranteed income for the rest of your life. The level of income you receive (or the cost of that income) can depend on a number of factors, including;
- The size of the pension pot that you use to purchase the annuity
- Whether you would like the income to keep pace with inflation
- Whether you would like the income to continue to be paid to a dependent in the event of your death (and for how long)
- The prevailing market interest rates and government bond yields (ok, getting a bit technical now, sorry!)
The popularity of annuities
Ok, so far, so good. ‘What’s not to like?’ I hear you cry! Well, not everyone saw it that way. People like choice. We rebel against the ‘one-size fits all’ approach. Always have, always will. The fact that purchasing an annuity used to be compulsory at age 75 only added to the hatred some people felt for them. The low (and increasingly lower) returns on offer over the last few years did little to change that view.
However, everything changed in 2014 when the ex-chancellor, George Osborne, rode in on his white ‘pension freedoms’ horse and saved the day! George believed that people who had worked hard, saved all their lives, and had done the right thing, should be trusted with their own finances.
This was the game changer. The biggy. This was the invention of fire, the wheel, electricity and Sky Sports all rolled into one! Pensions freedoms meant people could take their whole pension as a lump sum if they wanted. They no longer had to purchase an annuity at age 75. Sales of annuities plummeted. Ferrari salesmen rubbed their hands together. Casinos installed extra stair lifts.
Although it is estimated that around £25 billion* has been withdrawn to take advantage of the new rules, it turns out people are a bit more sensible than first thought. We didn’t go out en masse and blow all our retirement savings, but instead used the cash to pay off debts, help other family members get on the property ladder, start new businesses or provide an income before State Pension age. So, panic over then? No need for annuities anymore, right? Wrong!
Who should consider purchasing an annuity?
They are not for everyone; I agree. Purchasing an annuity with some, or all, of your pension pot is only suitable in certain circumstances. It is our job at Mearns & Company to identify when they are appropriate. The following points should be considered.
Increasing life expectancy
On average, we are all living longer. There are now around 15,000 centenarians (people over 100) in the UK. The queen can’t keep up with the telegram demand. She will soon have to send an email or tweet.
If you live to the grand old age of 100 then you will spend a lot of money in your retirement. That is certain. There could be a real worry that your money might run out. Buying a guaranteed income with some, or all, of your pension pot could guard against this. It can be a wise decision to make sure your day-to-day living expenses are covered. Taking away this worry can give you some valuable peace of mind.
As annuities have evolved, so has the length of the guarantee periods that are available. You are now able to choose 30 year guarantees that will continue to pay an income to your chosen beneficiary for the remainder of that period, even if you die soon after purchase. This is a very attractive feature, which can result in total income payments which will exceed the original amount used to purchase the annuity.
When purchasing an annuity, having a health condition that reduces your life expectancy could work in your favour. The insurance company may not think you will live as long as the average person (they obviously don’t know how stubborn you are!), so is willing to offer you a higher level of income than you would otherwise receive if you were in good health. This is called an enhanced annuity. Depending on what figures you use this could increase your income by anywhere between 17-27%.
New innovative products
The options for accessing income in retirement are constantly changing and developing. Some providers now offer products that combine a flexi-access drawdown product with an annuity. This has the added advantage of allowing the income from the annuity to be paid to a cash account, from which the client can decide when they wish to withdraw income. This makes it easier to alter income levels as part of a tax-efficient retirement strategy.
Purchased life annuities
Like an annuity purchased from your pension, a purchased life annuity allows you to exchange a non-pension lump sum for a regular, guaranteed income. Purchased lifetime annuities treat part of the income as a return of capital and pay it to you tax-free. This may result in a higher net income being received.
The road ahead
So, is an annuity right for you? Well, as always in finance, it depends. We don’t know what your retirement will hold, but we can guarantee that Mearns & Company will always adopt a thorough, professional approach in considering all available retirement options and working with you to develop the most appropriate retirement strategy to meet your goals and objectives.
Kevin Collie DipPFS
* Downes, S. (2019). ‘How pension freedoms have given savers a £25bn windfall’, The Independent, 16 May