Pension freedoms have given more savers a menu of choice beyond annuities, enabling those with a greater appetite for risk to stay invested.
Annuities therefore tend to appeal to risk-averse retirees who, in return for a guaranteed income, are willing to forgo flexibility and the ability to manage their fund, notes Mark Ormston, director of propositions and corporate partnerships at Retirement Line.
While annuities offer a ‘sleep at night’ solution to retirement income, low rates have made the argument for choosing drawdown over an annuity strong for many years, says Faye Church, senior financial planning director at Investec Wealth & Investment.
“The low level of income from an annuity purchase has meant that more and more people have been turning to drawdown, even if they have been risk averse.”
But pension freedoms have also enabled more savers to enjoy the benefits of both guaranteed income and investment risk.
“What we have experienced with clients that have a lower appetite to risk and lower tolerance to loss is a combination of... an annuity purchase to cover the fixed expenditure items, such as utility bills and everyday household expenditure, and income drawdown to cover the non-essential items, such as travel and luxuries,” says Church.
A pension can also be divided into two or more pots, she adds. “One pot is invested with a lower risk profile, which will provide drawdown income in the more short-term and therefore not be affected by volatility as much, leaving the medium to longer-term pot invested with a higher risk profile, which can ride out any market volatility and hopefully benefit from the longer-term upside potential.”
Cecilia Furner, interim distribution director – retail annuities at Legal & General, argues that a binary approach to drawdown or annuitisation "no longer exists" as there is a growing body of empirical evidence that demonstrates how integrating annuities within a retirement portfolio can deliver better outcomes.
Furner adds: "The PPI has identified six retirement needs/archetypes for clients in retirement; it concluded that most archetypes will benefit from a combination of access to flexible withdrawals and guaranteed income.
"Evidencing the sustainability of income is a crucial factor in every review meeting. A layered and phased approach to annuitisation can improve overall outcomes for many clients in retirement. Now is the time to consider how you can incorporate guaranteed income into your clients’ portfolios."
Stephen Lowe, group communications director at Just Group, describes annuities and drawdown as complementary solutions. The former helps protect retirees against the downsides of investing, while the latter can help them benefit from the upside.
“For most clients it won’t be an either/or choice, but getting the balance right between the two,” Lowe says.
“Retirees face two big problems: their investments may deliver poorer than expected returns, and if they take too much income their pension may run out if they live a long time. Uniquely, annuities address both investment and longevity risk.”