Articles - Are annuities the comeback kid for DC

Before the pension freedoms, annuity sales were in the region of 350,000 each year. Immediately after, this reduced to around 90,000 a year and since 2016, sales have slowly crept back up to around 140,000 a year. Annuities are often seen as the best way to provide a retirement income for life but there are now other ways of achieving that, namely drawdown. Will annuity sales creep up further and do annuities have a key role to play in retirement planning?

 By Kathryn Fleming, Partner at Hymans Robertson

 I have spoken to many various pensions forums over the years and the feedback you often get is a tale of two halves. Annuities don’t deliver good returns relative to being invested, they are irreversible and considered expensive to purchase at age 65. The flip side is that they offer guarantees, inflation protection, longevity protection and those that have purchased them are generally pretty happy with them. I can’t disagree with any of this feedback, but perhaps the comments need to be considered through a range of different lenses.

 It’s no secret that the pension freedoms have introduced a whole host of complexity for retirees to navigate, but what this often boils down to is finding a way for retirees to engage with their own health, wealth and family priorities and trying to establish whether these are best served by cash, drawdown, annuities or a combination of options.

 The average lifetime annuity rate achieved by annuity customers aged 65 for the first 3 quarters of 2021 was 5.2% (source: Retirement Line). For retirees that have a low appetite for financial risk, want a guaranteed spouse benefit and prefer to manage their money like they are still receiving a salary, these rates are not entirely unattractive.

 With the Retirement Living Standards becoming more common place, we could see an increase in retirees using their State Pension combined with an annuity top up as their mechanism to deliver the minimum income level in retirement. This would mean cash, drawdown or other savings could be used to manage additional wants and needs above that level.

 If the aim of retirement planning is to provide a retiree with an income for life, you could maximise the overall financial outcome that a member could receive, compared to annuity purchase at age 65, by splitting a DC pot at retirement. For example, our analysis suggests that using 80% to support drawdown and leaving the 20% invested until age 80 and then converting that pot to annuity purchase can lead to a better financial outcome whilst managing risk. The balance between drawdown and annuity can be adjusted to reflect individual member risk appetites and their wider circumstances.

 If we stick with the objective of providing an income for life, a fixed term annuity could be used to plug the income gap between a private DB pension coming into payment (say at age 60) and the State Pension coming into payment (say at age 67).

 What I think is perhaps the best (or unfortunately one of the worst) kept secrets of annuities is that over the last 10 years, on average the “enhanced” annuity customers have received around 19% extra in annual income compared to standard annuities (source: Retirement Line). For a retiree that is switched on enough to get enhanced annuity pricing, the income they could receive would really challenge the returns from investing in drawdown.

 An enhanced annuity will consider up to 1,500 different health and lifestyle factors and an annuity broker can add value by getting a member comfortable enough to share the right information to get the best possible price. An employer or trustee can add value by appointing an annuity broker (and negotiating a commission cap) but at a minimum raising awareness of enhanced annuities as an option.

 Retirement planning is hard and retirees face a range of different choices, some of which will really be determined by the complexity of their own personal circumstances. I do not foresee that annuity sales will return to the pre-pension freedom levels in the near future, but it is clear that for some, they are a pretty sensible option to consider.  

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