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.
Steady sales
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.
Understandably, drawdown has been more popular, with £6.1bn invested split across 90,700 plans with the average fund just shy of £67,500. If anything, this data shows that the lure of a guaranteed retirement income remains attractive, despite annuities’ reputation being trampled on in many corners.
“The market is actually increasing again,” says Steve Lowe, group communications director at Just Retirement. “The fundamental structure that drives growth is an increasing population that are starting to draw retirement benefits, and those fundamentals haven’t changed.”
Time to cash in?
Selecting the method and means of income in retirement is one of the most important financial decisions an individual will face. The decision of whether or not to annuitise can have significant consequences, as it represents one of the few financial transactions that is currently irreversible. But this could be about to change.
The secondary annuity market is due to be launched in April 2017, and it is designed to provide the facility for existing annuities to be sold for cash. This is likely to suit annuity holders with sufficient income from other sources that have a desire or a need for capital.
As a result of the perpetual fall in annuity rates, those who have secured annuities at previously high rates could be tempted to cash in due to the attractiveness to others of a rich source of secure income. This implies that annuity holders should think carefully before trading this income source.
Mr Cameron says, “I would be very concerned if that was the sole reason people considered this, because they have got a valuable asset that would cost an awful lot to buy today. You should think hard about how you will secure a future income from the proceeds.”
Advice allowance
At the end of August, the government unveiled a consultation paper outlining its commitment to assist those planning for their retirement. This was further to the Financial Advice and Market Review (FAMR), which set a case to allow consumers access to their pension arrangements to cover advice fees. As a result, the Pensions Advice Allowance is due to come into force in April 2017 and will allow policyholders the facility to withdraw up to £500 to pay for advice.
In addition, the government announced at the last Budget that it would increase the tax exemption for employer-arranged pensions advice from £150 to £500, and remove the rules around employers being fully liable when spending more than £150. The only lingering concern about these plans is whether £500 will be sufficient to remunerate advisers.
Mr Lowe says it could be prudent to combine the two options to encourage potential users to seek advice. “If your employer says ‘we can give you a £500 advice voucher, but you need to match it and we can help you facilitate that through your scheme’, that might be a really smart way of behaviourally motivating someone.”
Enhancing your income
According to Table 1 (below), produced by Hargreaves Lansdown, a straightforward level, single-life annuity for a 65-year-old will provide income of £4,503 based on a fund value of £100,000 – showing that the most basic annuity still falls far short of producing income of 5 per cent pa. This worrying data only serves to increase the requirement for consumers to seek out highest possible retirement income. Mr Lowe highlights some further concerns about consumer behaviour.
| Highest annuity rates as at 15 September 2016 |
| Age | |||||
| 55 | 60 | 65 | 70 | 75 | |
| Single life, level, no guarantee | £3,461 | £3,863 | £4,503 | £5,291 | £6,500 |
| Single life, level, 5-year guarantee | £3,459 | £3,856 | £4,495 | £5,262 | £6,418 |
| Single life, RPI, 5-year guarantee | £1,676 | £2,036 | £2,635 | £3,281 | £4,307 |
| Single life, 3% escalation, 5-year guarantee | £2,207 | £2,503 | £2,955 | £3,690 | £4,729 |
| Joint life 50%, level, no guarantee | £3,220 | £3,577 | £4,105 | £4,754 | £5,715 |
| Joint life 50%, 3% escalation, no guarantee | £2,014 | £2,266 | £2,635 | £3,200 | £4,018 |
Source: Hargreaves Lansdown. Copyright: Money Management.
He says, “We’ve seen the level of shopping around reduce since pension freedoms were introduced. The FCA told us in 2015 that nine out of 10 people get superior deals when they go to the open market.”
Exercising the open-market option has never been more important, and this should be coupled with disclosing the relevant medical information to check qualification for an enhanced or impaired annuity.
Mr Lawson says there are serious developments in this area – likely to surface in the next few years – that will provide a much-needed boost for retirees looking to obtain the highest possible annuity. “The ultimate endgame with is that every annuity will be underwritten. We will get to the point where everyone gets their own individual price.”
Perfect blend
Regardless of the problems faced, the argument for annuities is still strong given the need for the workforce to replace salaries with another form of guaranteed income. Further to this, the decision to annuitise or enter drawdown does not necessarily need to be as cut and dried as selecting one or the other. In many cases, a combination of the two can be the best strategy.
But for a retirement plan to be carefully constructed, advice is almost imperative in order to ensure pension provision can meet guaranteed and flexible expenditure. Mr Lowe describes this approach as “mixing and matching” and says it adds weight to the importance of annuities despite the effect of pension freedoms.
He says, “The only true freedom is knowing how much you’ve got to spend every month. If this isn’t the case, have you got freedom or uncertainty?”
