The start of a recovery in the UK annuity market suggests that consumers in today’s post-pension freedoms world still value the benefits of a guaranteed income for life.
If anything, the increasing number of people retiring with defined contribution (DC) pensions, combined with a potential uplift in annuity rates, is likely to drive even greater demand for annuities over the coming years.
Annuities will not be the right choice for every customer, but they are nonetheless important products that should form part of every adviser’s retirement toolkit.
Green shoots of recovery
It is a well-known fact that the annuity market has suffered greatly since former Chancellor George Osborne announced in March 2014 that “no one will have to buy an annuity”.
In the last quarter of 2016, annuity sales fell to their lowest level this century, with just 17,000 contracts put in place, according to figures from the FCA. This is compared with sales of 89,000 annuity contracts in the second quarter of 2013 – a decline of 81 per cent.
Yet it is widely thought that the bottom of the market has now been reached, and we are starting to see the green shoots of recovery.
A note by analysts at RBC Capital Markets last year estimated that annuity sales will grow by 5 per cent annually, as greater numbers of people retire with DC pension pots. The ABI, meanwhile, has predicted there will be a steady increase in annual annuity sales into the 2020s.
>Auto-enrolment is creating a new era of pension savers who will need advice about their retirement income options.
Although much of this growth can be attributed to consolidation in the annuity market, it is another positive sign of the market’s recovery.
Improving gilt yields, higher interest rates, growing DC pots, potential equity market volatility and an ageing population all point towards an expanding annuity market.
It’s worth noting that people aged 65 and over will make up nearly 20 per cent of the UK population by 2024.
Far fewer retirees will have a defined benefit (DB) pension than was the case in the past, yet many will still be seeking the security of a guaranteed income.
The latest figures suggest 85 per cent of active scheme members in the UK are in DC schemes.
At the same time, auto-enrolment is creating a new era of pension savers who will need advice about their retirement income options.
There was a 33 per cent increase in occupational scheme membership between 2010 and 2015, and it’s likely that many of these members will have substantial DC savings when they retire.
Annuities could play an important role in many of these potential clients’ retirement income plans.
The value of annuities
The value that annuities offer has been somewhat overshadowed by the drop in annuity rates and the focus on flexible income drawdown. In the past 10 years annuity rates have fallen by about 50 per cent, in line with a drop in long-term interest rates and improving life expectancy.
However, gilt yields have been slowly increasing since 2016, which together with potentially higher interest rates could boost annuity rates in the future.
If economic uncertainty and stockmarket volatility persist, we could see people flocking to the guaranteed income that annuities offer, as returns become more attractive.
It could also be argued that annuities offer more inherent value today than in the past, despite the drop in rates.
Many people are receiving annuity income for far longer than their parents’ and grandparents’ generations, because of the significant increase in life expectancy.
In 1950, male life expectancy was just 82.5 years, compared with 93.6 years in 2016. Meanwhile, female life expectancy has risen from 77.9 to 90.8 years over this same period, according to the Office for National Statistics.
>Another often overlooked feature of annuities is they do offer flexibility, albeit not to the same extent as income drawdown.
This increase in life expectancy means of those who took out an annuity with Legal & General 20 years ago, nearly 77 per cent are still receiving an income today.
Modern annuities can also provide valuable death benefits. Guaranteed minimum payment options can ensure that if the policyholder dies during their chosen payment period, income will continue to be paid to their estate until the end of the period.
An annuity can also pay an income to the policyholder’s surviving spouse or civil partner, if the policyholder dies first.
Both options help people to leave something behind for their loved ones when they die.
Another often overlooked feature of annuities is they do offer flexibility, albeit not to the same extent as income drawdown.
Income can be tailored to the client’s needs at the outset through a fixed income for life; increasing income by a specified percentage each year, or rising in line with the Retail Price Index (RPI) as an inflation-proofing option.
Fixed-term annuities can also be used as a way to provide a guaranteed income for a defined period of time, enabling the customer to reassess their options later in retirement but without leaving them exposed to investment risk.
Moreover, clients who have certain health or lifestyle conditions, such as cancer, high blood pressure or being overweight, may be entitled to receive a higher income. This is because their condition may affect their life expectancy.
Annuities for the modern retiree
Modern retirement planning needs to reflect the changing needs of today’s retirees.
It is no longer the case that people stop working at age 60 and take their company pension.
The number of people who work beyond state pension age has risen from 753,000 in 1993 to about 1.5 million now.
Two-thirds of those choose to stay working on a part-time basis, and many other retirees volunteer or care for their grandchildren.
Rising longevity means that retirement is no longer a “once and done” decision. Some retirees spend more than 20 years in retirement, and their needs at age 80 could be vastly different from those at age 65.
Although annuities are not suitable for some people at certain stages of retirement, they do fill an important need.
As retirees age, they’re more likely to become risk-averse and value the stability of a guaranteed income.
Annuities aren’t, however, just for the very elderly.
If someone takes a phased retirement, it is possible for them to partially buy annuities, to gradually reduce the investment risk on pension pots.
>The stability provided by an annuity may also boost clients’ confidence about investing in the market to increase their retirement savings.
Additionally, people who have small pension pots can benefit from guaranteed lifetime income or fixed-term annuity products – rather than withdrawing money, putting it in a low-interest rate bank account and facing onerous tax charges.
In many instances, clients could gain from a combination of drawdown, lifetime annuities and fixed-term annuities in their retirement plan. It doesn’t have to be an either/or decision.
Annuity income can help to pay for fixed expenses, such as regular monthly bills, while income drawdown can be used for discretionary expenses.
The stability provided by an annuity may also boost clients’ confidence about investing in the market to increase their retirement savings.
In essence, it could be a “best of both worlds” solution that puts more tools at the adviser’s disposal.
The role of the adviser
The role of advisers in retirement planning is more important than ever before.
Clients face tougher income decisions and greater uncertainty about how to ensure their savings will last them for the rest of their lives.
A recent review by the FCA into non-advised drawdown sales also found that a large number of customers were not aware of the full suite of retirement income options available to them. The report even found that some individuals were pre-emptively choosing to move into drawdown, or were failing to think about their investment choices.
Since the pension freedoms, retirement planning has become an ongoing process and that could lead to more clients wishing to see their adviser on a regular basis.
This offers the opportunity for advisers to introduce annuities at the right stage in their client’s retirement – and ultimately provide better outcomes for consumers.
A major challenge, however, will be overcoming the misconceptions about annuities among the general population, such as being poor value for money and inflexible.
That’s where annuity providers and advisers have an important role to play.
Although there has been a lot of negative press around annuities, research suggests many consumers would still benefit from a guaranteed income.
A report commissioned for the government’s Foresight Future of an Ageing Population project, found that people with DC savings who do not purchase a secure income product, run a greater risk of running out of funds before their death than those who do.
This is exacerbated by the fact that people consistently underestimate their own life expectancy, on average by three to five years among 60-year-olds.
This means they might draw down larger amounts of money in anticipation of a shorter lifespan.
In 2011, an individual withdrawing an income from their drawdown account equal to 100 per cent of what they would have received from an annuity, would have had a 36 per cent chance of depleting their funds before their death, according to the Pensions Policy Institute.
People now face complex choices that are compounded by uncertainty about future legislative changes, health, longevity and inflation, as well as the tax and benefit implications of accessing DC pension savings.
Advice is therefore essential to ensure clients are choosing the right option at the right time and don’t risk depleting their savings in retirement.
The time is now
Annuities have suffered from a great deal of reputational damage in recent years, but the value of a regular, safe income in retirement should not be overlooked.
Annuities can play an important role in retirement planning – whether it’s at the outset, as part of a phased retirement, or in combination with income drawdown.
The market has already started recovering from its downward spiral following pension freedoms, and this recovery is expected to continue as the number of retirees with DC pension pots grows.
Therefore, it is an ideal time for advisers to speak to their clients about their retirement options and the value that annuities offer.
Emma Byron is managing director for individual annuities at Legal & General