Articles - Annuities are not as simple as you think

There are some truths in life that we are all aware of but don’t really hit home until you are facing them in practice. Such as our new puppy who is incredibly cute, but has required us to pretty much rearrange the entire house so that he can’t chew, get stuck behind or electrocute himself on anything. More pertinently, I also spent time during the Christmas lull revising our retirement options material and found myself writing pages more on annuities than the supposedly more complicated drawdown options.

 By Fiona Tait, Technical Director, Intelligent Pensions

 The fact is that annuities are simple - once you’ve bought them. This is good news for the annuitant if they have chosen the right ‘shape’ at outset, but it is less helpful if they experience a life change which means the income provided no longer matches their needs or they have lost out on initial income in favour of an option which it turns out was not required. The FCA has tended to focus on the risk attached to income drawdown but at least under that option it is possible to change tack at any time. With an annuity you’re stuck.

 It is therefore remarkable that so many people are still left to their own devices when making one of the biggest – and irrevocable – decisions of their life.

 Decisions, decisions
 Historically the timing of annuity purchase was usually driven by either the scheme retirement date (NRD) or the State Pension age (SPa), and the annuity was usually bought all at once. This still left the key decisions of whether to insure against dying early, protecting income against inflation and making provision for a spouse/partner, but as long as the initial income was high enough to meet their needs, most people just settled for what they could afford.

 With the advent of income drawdown and, later, pension freedoms these choices expanded to include delaying or avoiding annuity purchase, phasing and using combination plans. Retirees now have to choose not just whether to annuitise, but when and how.

 Thanks to a certain speech in 2015 many of our clients confidently state that ‘I never want to buy an annuity’. This is very often down to poor rates (especially for young retirees) but also lack of flexibility and less generous death benefits. They do however like the concept of a secure income and as time goes by the other objections could become less pertinent. Rates tend to improve with age, and income needs also tend to become more predictable. Death benefits are still undeniably less favourable than drawdown but may be less of an issue for those with adult children.

 Health is another key factor. It is incumbent on advisers to always check if enhanced rates are available, but it also means that the client may have less time and energy for the necessary annual reviews and ongoing decision-making.

 The good news is that clients do not have to commit their entire fund to an annuity but can phase their purchase or use one of the hybrid options available to provide an income underpin and other guarantees.

 Another objection to annuities is the lack of potential for growth. Clients can understandably be reluctant to purchase escalation when they see the impact on their initial income level, and there is always the chance that if they die early, they will never catch up with the value they would have had from a level annuity.

 For those who have an appetite for risk, the hybrid options may deliver what they want, and investment-linked annuities are also available on the market. It does mean however that a choice still needs to be made regarding what to invest in and what rate of return they should anticipate is likely to provide increasing income.

 Death benefits
 Most, if not all, of our clients are unhappy with the idea that an annuity dies with them, or even with a spouse’s pension which continues at a lower level. We do try to emphasise the value of a lifetime income, which could be paid for many years past the time when the fund itself would have run out, but another truth is that people tend to underestimate how long they will live and overestimate how much they can afford to spend without running out.

 Clients who have never had income drawdown may find it easier to see the product as an insurance product rather than an investment, but others may only be reconciled with the addition of capital guarantees or return of fund via one of the hybrid products.

 Financial advice
 At the end of the day, the financial advice profession has become adept in recent years at assisting people with drawdown choices, but we do also need to help them to find suitable annuitisation strategies.

 This is important not just for the much-reduced number of people opting for an annuity when they first access their benefits, but also because of the increasing numbers of early drawdown investors who are now reaching the age when annuitisation could be the best things for them.

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