Following last month’s Budget, many people, for journalists to so called industry experts have predicted the death of the Annuity.
We don’t believe this is the case, in fact to paraphrase Mark Twain, “reports of the death of Annuities has been greatly exaggerated.”
Don’t misunderstand us, we firmly welcome George Osborne’s proposals, to give people greater access to their pension pot. The increased flexibility will benefit many people when they come to retire and also encourage innovation from product providers.
However, we believe that for many of the half a million or so who retire each year, an Annuity will still be the best way of turning their pension pot into an income.
So, who will an Annuity still be right for?
1. Those people who want a guaranteed income
An Annuity is currently the only way of getting a guaranteed income for the rest of your life, and if you include a spouse’s pension, that of your husband, wife or civil partner,
For people, who do not want to take the investment risks often associated with other options, such as Income Drawdown an Annuity is the only option.
2. People who are in ill-health
As an industry we like to think the message about Enhanced Annuities is getting through. But with 60% of the 420,000 Annuities set-up in 2012 being bought from the existing pension provider, the opposite seems to be true.
Put simply, those people with health problems or lifestyle issues will get a better Annuity rate than those without such problems. But, even relatively innocuous conditions can qualify, as well as other factors such as your parent’s age when they died, even your level of education and the type of alcohol you drink.
Indeed research from Partnership, a provider of Enhanced Annuities, suggests that 50% of people retiring could qualify.
And here’s the important point: the income from an Enhanced Annuity is often significantly higher than maximum, sustainable income, available from other options. Sure, the new rules will allow you to take more money each year from an Income Drawdown plan than was previously the case, but will higher levels be sustainable? Or will your pension pot die before you do?
Of course on the other hand, the Annuity is far less flexible and once set-up no changes can be made.
3. People who want a one-off solution
At present, every other solution for turning your pension pot into an income, such as Income Drawdown, Investment Linked Annuity, Fixed Term Annuity, and Flexible Drawdown, requires some degree of on-going management by you or your adviser.
An advantage of an Annuity is that it requires no on-going management; this can also work as a disadvantage too. Once it has been set up it can never be changed, for some people this certainty is a positive thing, for others it’s a negative as it can’t be altered to reflect their changing circumstances.
4. People who want a better return than they can get elsewhere – part one
One of the options people will have under the new proposals is to take the entire pension fund as a lump sum and then spend or save it.
But, for those people who save it, perhaps in a Cash ISA to shelter the interest from tax, they are likely to see a lower return, compared to the income they could get from an Annuity.
Let’s have a look at the numbers.
The best rate currently available is 3% per year from the Skipton Building Society (Source: Investment Sense ).
How does that compare to an Annuity?
For a 65 year old couple, wanting a joint life Annuity, 50% spouse’s pension and a 10 year guarantee a level Annuity would offer a rate of 5.68%. Even an Annuity which will rise each year by 3%, helping to protect against the effects of inflation, will pay 3.86% per year.
We also need to remember that only 25% of the pension pot is available as a tax-free lump sum, the rest will be added to your income and subject to tax your highest marginal rate, leaving less to put into the Cash ISA
5. People who want a better return than they can get elsewhere – part two
If you want the income from your pension to last until you die and you use any other option than a Lifetime Annuity (Enhanced or otherwise), the amount you take each month has to be sustainable.
In short, that means not taking out of the pot, in income and charges, more than is being added back through growth.
Let’s look at the numbers again for a popular Annuity alternative, Income Drawdown:
We’ve seen that a level Annuity currently pays 5.68%, this could easily be increased to 6% – 7% for an Enhanced Annuity (Source: Investment Sense ).
If the charges for the Income Drawdown plan, including those for any platform used, investment funds and advice came to say 1.5%, this would mean a total return of between 7.18% and 8.5% is needed to equal the income given by the Annuity.
How much risk would you have to take to achieve this? Probably a significant amount.
It would certainly mean taking more risk than is involved with an Annuity and having a proportion of your pension pot invested in assets, which could fall in value.
The questions you need to answer:
- Are you happy to take this level of risk?
- Are you happy to manage the investments yourself, or pay someone else to do it for you?
- Would you be able to reduce your income if your pension pot fell in value?
- Are you happy to see the value of your pot reduce over time if you take more out than is being added back in?
If the answer is “no” to all these questions, then perhaps an Annuity is for you after all.
6. You want a secure income
We’ve already said that an Annuity is the only retirement income product which guarantees you an income for the rest of your life. But what happens if your Annuity provider goes bust?
To start, because of the strict regulatory capital requirements Annuity providers have to comply with, this is unlikely and has never happened. However, if it were to happen the Financial Services Compensation Scheme (FSCS) would step in and pay 90% of your income, with no upper limit.
Options and choice, we’re here to help
The new proposals will certainly provide you with more flexibility when you reach retirement, but for some, after this greater degree of choice has been taken into account, an Annuity might still be the right option.
If you need help deciding which option is right for you our team of Independent Financial Advisers are experienced in developing retirement income strategies for clients the length and breadth of the UK.
Call one of our IFAs today on 0115 933 8433, alternatively enquire online or email email@example.com