Those looking to secure income at retirement are facing more challenges than ever before. Increasing longevity and decreasing annuity rates is leaving retirees with a sizeable task when attempting to secure a guaranteed income in later life.
Although the pensions freedoms have provided greater flexibility when taking retirement benefits, a rock-solid income remains a preference – or necessity – for many, along with the peace of mind of knowing that expenditure can be constantly accounted for, too.
Annuities are the main vehicle that can provide this guaranteed income, but they have come under scrutiny in the past few years, with many unhappy with their rigidity and the dramatic fall in rates available.
Because of this, it was feared the introduction of pension reforms could force annuities into extinction, as those with smaller pots opted to take their pension pot in cash, and those with sizeable funds sought the flexibility associated with income drawdown.
“[Annuity] reputation has taken a bit of a battering recently. A significant, anti-annuity sentiment has grown over a number of years,” says Steven Cameron, pensions director at Aegon.
Although his organisation fully exited the annuity market earlier in 2016, Mr Cameron believes the products remain an essential retirement consideration.
“Annuities will always have a place for people who want a secure regular income for life and are not concerned about flexibility or leaving money for the estate.”
John Lawson, head of policy and retirement solutions at Aviva, explains that although both are focused on retirement, annuities and drawdown have highly differing functions. Mr Lawson says, “An annuity isn’t really an investment product, it’s an insurance product. It insures against the risk of outliving your savings.”
He adds that retirees are increasingly aware of this distinction, especially when economic conditions are poor. “Volatility in equity markets and commercial property can put them off drawdown because annuity quote volumes and purchases go up when investment markets are volatile.”
In August, the Bank of England (BoE) cut interest rates to a fresh record low, and it’s the knock-on effect on gilt yields that will have an impact on annuities.
Falling gilt yields have been a significant factor in lowering annuity rates. Despite recovering after reaching a then-record low of 1.68 per cent on 30 January 2015, 15-year gilt yields have again started to decline this summer – and sharply.
Yields fell to 1.3 per cent following the Brexit vote, then below 1 per cent once interest rates were cut, and have subsequently settled at around 1.1 per cent, signalling a difficult future in the fixed-interest arena.
Mr Lawson explains that providers can also turn to equity release loans and commercial property to invest annuity capital, but gilts remain the preferred vehicle as they are seen as a safe haven.
Data from the Association of British Insurers (ABI) shows that annuity sales have been reasonably steady since inception of the freedoms, with quarterly totals ranging from £950m to £1.17bn over the 12-month period. A total £4.2bn has been invested in around 80,000 annuities, making the average vested fund nearly £52,000.