Pension freedom is now with us, and with it, the flexibility for us to choose what we do with our pension ‘pot’ at retirement – spend it, use it for an income, leave it invested, or take any combination of all three (1).
What does this mean for annuities? Long a staple product for retirees, analysts have been widely predicting their demise ever since the Chancellor’s 2014 Budget speech.
IS THIS ASSESSMENT FAIR?
It is certainly true that the annuity market has declined since pension freedom was announced. According to the ABI (2) sales in Q4 2014 were over 60% lower than the previous year and figures from leading annuity providers in 2015 appear to confirm that this trend has continued (3).
Despite the headlines, however, there does still appear to be a place for annuities. Some annuity providers are maintaining sales at around 40% or more of previous levels – so many people must still appreciate what they offer.
THE BENEFITS – AND DOWNSIDES
The main benefit of an annuity is that it offers a pre-agreed, fixed income for life, regardless of how long you live. In other words, even if you live past 100, you will still be receiving an income to help pay for some of the bills and small luxuries that make life enjoyable. Unlike other retirement income products, and with the exception of investment linked annuities, there is no stock-market risk which might reduce your income in the future or even eat it up completely.
The downside, however, is that if you do not live as long as expected, the residual value of the annuity disappears with you. There is usually no return of capital to your estate if you are one of the unlucky ones.
OPTIONS TO CONSIDER
However, there are ways to mitigate some of the downsides. You can opt to guarantee a minimum return, the equivalent of up to ten years income, in case the worst happens. If you are married or in a civil partnership, a joint life annuity would provide your partner with a continued income should you die first. And if you are worried about the impact inflation could have on your income over 20, perhaps 30+ years, you can choose an escalating plan. These increase your income each year by a set or inflation related percentage. The initial income in all these instances will be lower than a policy without such options, but the long term guarantees are worth considering in case the worst did happen.
Finally, if you know you already have health issues or lifestyle habits that may reduce life expectancy, then investigate enhanced annuities. These will take account of your situation and pay you more than standard annuities if you are eligible. Despite all the hype, therefore, the jury remains out on annuities and they could remain useful for many.
(1) Note that withdrawals from pension funds at or after retirement are tax free for the first 25%, but the balance is then taxable at your marginal income tax rate. Different rules apply to the tax treatment of lump sums & income passed to beneficiaries after your death, depending on what age you are when that happens.
(2) ABI Retirement Income statistics, Q4 2014, published 26 Feb 2015.
(3) Interim Trading Statements for two leading London stock market listed specialist annuity providers, published May 2015.
SIMPLY MONEY NEWSLETTER – SUMMER 2015