Down but not out: The case for annuities

Drawdown, an uncrystallised fund pension lump sum payment and encashments are the preference of younger pension holders, according to the regulator.

Annuities are more likely to be taken by those post-retirement age, with three in five (59 per cent) taken by people over the age of 65.

Jan Holt, strategic relationship manager at Scottish Widows, says: "Annuities should be given full consideration as they bring certainty and remove investment risk for some or all of the pension fund. You can also ensure that guaranteed income to cover essential outgoings is delivered – thus creating capacity for loss for each client."

Fiona Tait, technical director at Intelligent Pensions, says older clients are likely to be offered better conversion rates due to their shorter life expectancy, and are more likely to have health conditions that could lead to an enhanced rate.

Number of pension plans accessed for the first time by method of access

Source: FCA retirement income data

A paper by LCP likewise notes a good reason to think that moving away from income drawdown and purchasing an annuity might become more attractive as you get older, relating to the fact that the relative uncertainty of how long you may live increases as you age.

“As you get older you become much more likely to live 150 per cent or 200 per cent longer than expected,” the consultancy says.

“If you are worried about this risk you might decide to draw on your pot more slowly to protect against this risk. But this means a lower standard of living, and if you end up living the average amount of time you will end up with an unspent balance.

“Buying an annuity, which is guaranteed to last as long as you live, removes this longevity risk. And, given that the relative uncertainty around how long you will live rises with age, the attractiveness of an annuity will also rise with age.”

Steve Webb, a partner at LCP and the paper’s co-author, says that while forcing people into annuities in their late fifties and sixties was not the right approach, it would be “wrong to write off annuities altogether”.

Webb adds that for a wide range of people, there could come a point during retirement when a switch to an annuity gives them better outcomes overall.

Mark Ormston, director of propositions and corporate partnerships at Retirement Line, a pension income broker, says annuities will likely have a part to play in many people's retirement income planning at one stage or another.

This is especially the case for those who are not already benefiting from secure income, such as from a final salary pension.

“There will be many risk-averse people desiring a guaranteed income who will turn to an annuity to receive a known amount of regular secure income for their life, and possibly also their partners' life by way of a joint-life annuity, without any longevity risk,” Ormston adds.

Ms Holt adds: "Where a client doesn’t want to completely lose the flexibility of drawdown, but would feel comfortable with some certainty of income, it may be possible for them to have both.

"For example, using guaranteed income sources to meet essential outgoings means that the flexibility of drawdown is available for the rest of the fund – assuming that your client is willing and able to take on some investment risk."

The role of annuities

Annuities allow retirees to insure against the risks of poor investment returns and outliving their fund, says Simon Gray, managing director at advice company Hub Financial Solutions.

“An annuity has no ongoing fees and no need for a retiree to make investment or withdrawal decisions, which may become more difficult as people’s cognitive function declines with age,” Gray adds.

When it comes to annuities, Ormston at Retirement Line notes how savers are asked to build their own product.

“Like ‘extras’ when someone purchases a car – and of course, each option comes at a cost,” he continues.

“Understandably, the annuity market is price-driven, with the highest figures getting the most engagement.

“However, this approach comes with dangers. The most obvious ones are that unengaged people focus on getting the product up and running and/or people focus on the short term, [concentrating] on the highest income without potentially giving enough thought to the options available such as guarantee periods, value protection, joint life and increasing payments.”

Many retirees will benefit from having a secure income that is sufficient to cover at least their basic needs such as day-to-day living costs and household bills, which Gray labels as a ‘minimum income requirement’ that they cannot afford to lose.

“Once someone’s essential costs are covered for their lifetime, they can then consider how to use any remaining cash to generate cash for non-essentials and luxuries,” he adds.

“By securing a core level of income, they then have more financial and estate-planning opportunities because it gives them the confidence to invest, spend or give away other assets.”

Ormston likewise suggests a combination of the state pension and an annuity to cover essential household bills, after which any excess could be invested in drawdown providing flexibility and investment exposure.

“We are great fans of the [Pensions and Lifetime Savings Association's] Retirement Living Standards and feel many could look to the minimum Retirement Living Standard as a guide to support this approach,” says Ormston.

“For a single person, the current minimum Retirement Living Standard is set at £10,900 a year. For those receiving the full state pension of £9,339, this leaves a gap of £1,561 a year to reach the minimum level. 

“Based on current annuity rates, an amount of approximately £30,000 would purchase an annuity to provide an amount of £1,561 a year. Many people who are personally underwritten for health and lifestyle factors may benefit from a lower purchase price.”

Annuities may no longer be a default, but as Ormston remarks: “George Osborne didn’t say that no-one should ever buy an annuity again. He said that no-one will have to buy an annuity.

“He didn’t say annuities [are] bad, don’t buy them. He introduced choice, and for us annuities will still be a very viable choice for many.”

Chloe Cheung is a features writer at FTAdviser