Over the last year, rising annuity rates have led to a surge in sales.
But unfortunately, a recent Financial Services Compensation Scheme (FSCS) survey found that 19 million Brits aged over 50 are not considering annuities.
Respondents reported a range of reasons, including not knowing if annuities are right for them, fear of the provider going bust, not understanding how they work and a lack of protection if something goes wrong.
But are they missing out?
International Adviser spoke with Arbuthnot Latham, Atomos, Copia, The Fry Group, GBST, GPFM, Mercer & Hole, The Openwork Partnership, Progeny, Royal London, SG Kleinwort Hambros and Succession Wealth for their views.
A different retirement market
Times have changed, says Andrew Dixon, head of wealth planning at SG Kleinwort Hambros.
“While pension death benefits remain very attractive, it is difficult to see a return to pre-2008 levels,” he added. “The retirement market today is fundamentally different. Many people forget that there was little value in not taking an annuity at age 75 under the alternatively-secured pension rules. While annuities should certainly be considered, unless pension death benefits change it is difficult to see annuities returning to their pre-2008 levels.
“However, higher annuity rates mean higher returns from lower-risk assets, cash and government bonds. Therefore, even risk-averse, high-net-worth individuals are generally willing to trade the additional income potentially available from an annuity for the inheritance-tax benefits of pensions.”
‘Vastly different and better’
Scott Atkinson, managing director of GPFM Chartered Financial Planners, also points to a change in the landscape.
He explains: “Annuities have always had a place in financial planning, even when rates are not particularly attractive. Annuities offer certainty and are a useful financial-planning tool, particularly with more cautious and clients with less knowledge of investments.
“Certainly, annuities should always be fully considered where a client has a shortfall between guaranteed income and their non-discretionary spending. The range of annuity products and options now available is vastly different and better than 10-15 years ago.”
‘Annuities should not be ignored’
Jane Martin, chartered financial planner at Atomos, says annuities should be on the table from the start.
“Annuities should not be ignored and should be considered as an option. It is good practice to do this at the outset of advice, but also to review continuously. If they are not appropriate at the outset, they may become appropriate at a later stage. Clients’ health, marital status and other assets should be included as part of the annual review of income drawdown.
Partial annuities can be a good halfway house to secure ‘essential’ income for a household. Fixed-term annuities can help with shorter-term essential spending or tiding people over until other secured income, final salary and/or state pensions become payable.”
Consider basic outgoings
Michael Lapham, director of financial planning at accountants Mercer & Hole, added: “In our experience, the main reason most clients do not buy an annuity is not perceived low rates but the fact that they want to be able to draw pension benefits flexibly or that drawdown death benefits meet their needs better. The fact that we have seen an increase in annuity rates over the past year or two may not necessarily change this stance.
“However, in these instances we would still advise any clients whose basic outgoings, such as food and heating bills, are not covered by guaranteed sources of income to still consider purchasing an annuity with at least part of their pension savings, to meet these costs.”
Rachel Wyatt, wealth planner at Arbuthnot Latham, said: “As you approach retirement, you need to decide how to convert savings into an income stream. An annuity requires you to fix the terms on how your income will be paid at the outset. This decision can feel overwhelming, and clients can be quick to dismiss annuities, stating costs, a desire to retain control over their savings and a reluctance to give up income flexibility. It may feel like a more straightforward option to draw income direct from your savings, but your income is at risk. You remain invested in the market and the sustainability of your income will depend on the performance of the underlying assets.
“When you purchase an annuity, you transfer investment risk to the insurance company. For most pensioners, their main concern is having lifetime financial security, and so annuities can give a level of financial security, providing peace of mind that they will not outlive their savings. In exchange for a capital lump sum, you receive a secure and regular income that is 100% protected under the FSCS, with no upper claim limit.
“Good retirement planning should consider the ability of all the available options in meeting a client’s objectives. Understanding how best to meet your income requirements in retirement will depend on your individual circumstances, your need for guaranteed income and your tolerance and appetite for risk.”
‘Demands and objectives of a modern retirement’
Hayley Burns, wealth planner at Succession Wealth, says that annuities should always be looked at as an option.
She said: “Annuities should always be a consideration when it comes to retirement planning; having peace of mind that you have a guaranteed income for life can be a great option.
“However, as fewer of us nowadays have ‘traditional’ family set ups, whether by choosing not to get married or having been divorced, annuities have limitations. Many of us are looking to ensure that our beneficiaries, not just a spouse, receive as much of our hard-earned and unused retirement fund as possible. This understandably makes the idea of having to choose a traditional ‘guarantee’ period, which you may well live past, less desirable.
“I also find that more and more people are concentrating on enjoying the earlier years of retirement, with the knowledge that in later years they may well have less income available and are comfortable with that. My clients are increasingly content with knowing that they won’t be doing the same amount of travelling or socialising as they age.
“The ability to have a more flexible approach to retirement, whether that is to allow a partial retirement, retirement from a high-pressure job or simply to allow budget for travel, has become a priority for many. Although some annuity providers have introduced more innovative short-term annuities in recent years, making them more attractive in some cases, in my opinion, they have not caught up with the demands and objectives of a modern retirement.”
Opportunity for provider innovation
David Simpson, head of EMEA at GBST, said: “We think that annuities play an important role in later-life income planning. With changing life expectancy, wealth composition and expectations of retirement, advisers and investors are likely to need to take more of a ‘mix and match’ approach to income planning, using both guaranteed-income solutions and income drawdown to support income requirements, aligned to an individual’s needs through different stages of retirement.
“There is a huge opportunity for providers to create more innovative retirement solutions that combine annuities with flexi-access drawdown that sit alongside ISAs, general investment accounts and investment bonds on the same platform, to make it easier for advisers to meet their client’s retirement-income needs while optimising tax and death benefits.
“While the technology is already available to support the distribution of different retirement solutions within a single tax-efficient wrapper and alongside other retail investment products on the same platform, many traditional annuity providers are not currently set up to deliver a scalable new business proposition that meets the expected demand for these solutions.”
Financial Conduct Authority (FCA) focus on decumulation
Robert Vaudry, managing director of Copia, expects an increased use of annuities.
He said: “Annuities offer attractive rates of income and are uncorrelated to other assets, which makes them a useful part of a retirement income plan. At Copia, we’ve taken this idea a step further, building a decumulation strategy that works in conjunction with a guaranteed-income solution to increase the opportunity to outperform and provide greater certainty of outcome in retirement without increasing the overall investment risk.
“Using guaranteed income as an asset class in this way means we can offer investors in drawdown some protection against the effects of ‘pound cost ravaging’ by reducing the need to sell assets in unfavourable markets to generate income. More of the assets stay invested for longer, increasing the opportunity to outperform, without increasing the investor’s overall risk. As the FCA puts more focus on decumulation with its thematic review of retirement-income advice, we’d expect to see further innovation around investing for retirement and increased use of annuities as part of a combined portfolio.”
Changing requirements
David Owen, wealth proposition director at the Openwork Partnership, says: “We have all heard of the 4% rule – a rule of thumb that says if we invest in a balanced portfolio and take 4% per year, gross of cost and charges, the money should last 30 years – leaving £1 remaining. However, a 65-year-old male in the UK now, who gets whole-of-market advice, will be offered around 5%, inflation-linked, guaranteed, via an annuity. Or, for those who don’t expect inflation to ever feature again in the economy, 8.5% flat for life.
“Of course, each year our requirements change, and this is why an annual retirement-income strategy needs a tactical adjustment – using all the tools available.”
Clare Moffat, pensions expert at Royal London, says annuities have their place and should not be overlooked.
She added: “If you purchased an annuity in 2021, escalating by either CPI or RPI, you will be delighted with the growth in income because of the high rates of inflation. If you didn’t choose escalation, you’d be in a very different position as the purchasing power of your income will be reducing significantly.
“However, if you did choose an escalation option, it will have greatly reduced your income level at outset, though that income will be increasing now. Although these vagaries make annuities seem complex and can be difficult to explain, they shouldn’t be completely disregarded. Retirement will depend on an individual’s needs and while annuities aren’t for everyone, there are scenarios where they could be beneficial, so they should be considered as part of the retirement planning process.
“Many want complete flexibility with their retirement income, which explains the popularity of drawdown, while for others, buying an annuity offers them the comfort of a guaranteed income. As people get older, some are keen to introduce a form of guarantee, so a happy medium for many is an annuity to cover basic living costs, providing comfort and reassurance, while leaving the rest invested for extra flexibility.”
Limits future options
Huw Wedlock, director at The Fry Group, Singapore, said: “Brits have largely turned their back on annuities over the last 15 years, but now could be a good time to reconsider. One of the key drivers concerns interest rates, which have risen sharply over the past 18 months. Given that annuity rates largely follow interest rates, it’s clear that locking in a long-term, guaranteed income stream in the form of an annuity now makes much more sense than it has in the past 15 years.
“An annuity can provide a guaranteed income stream for life − one that isn’t dependent on underlying investment performance. Annuities can have additional levels of flexibility built into them too, such as single or joint-life options, spousal benefits and indexed annuity payments, as well as capital guarantees.
“But it’s worth bearing in mind that buying an annuity is a one-off decision and does limit future options when it comes to accessing any pension savings. Remember too that no further death benefits are available following annuity purchase, once the person receiving them has passed away. Pension drawdown remains the most flexible way of accessing retirement pots.”
Dean Kemble, chief commercial officer at GSB Capital, added: “With changes within UK pensions regulation over the past 10 years and with interest rates historically low until recently, annuities have not been seen as a preferred option for most with a sizeable pension.
“Annuities and fashion do not usually go hand in hand in a sentence. Still, with interest rates rising, there is reason for them to be considered as a solution for retirement income. I believe several factors discouraged people from considering annuities as a feasible option for their retirement funds in the past.
“Once an individual purchases an annuity, it typically cannot be changed or reversed, making it inflexible. This may cause hesitation in committing a large portion of one’s savings to an annuity, mainly if one needs to access those funds for unexpected expenses or emergencies. When an individual decides to purchase an annuity, they must understand that they are surrendering control of their principal. This means that they will not have the ability to make investment decisions or access the lump sum of their money.
“While annuities provide a guaranteed income stream for life, some individuals may be concerned about ‘wasting’ their money if they pass away relatively early after purchasing the annuity. They worry that their heirs won’t receive a substantial inheritance. As there are many options, including level annuities; escalating annuities; inflation-linked annuities; impaired or enhanced annuities; lifetime annuities; joint-life annuities and short-term or fixed-term annuities, professional advice should be sought.
“Although annuities may not be suitable for everyone, they can still provide significant benefits to individuals who want a reliable income source during retirement and protection from the risk of running out of savings. With interest rates rising, the option should be more of an informed consideration than in the past, when interest rates were low. Before deciding whether an annuity is the right choice, it’s crucial for individuals to seek advice from a financial adviser and to evaluate their financial goals, risk tolerance and overall retirement plan. This will help individuals understand the advantages and disadvantages of annuities and other retirement-income strategies.”
‘A niche product’
James Batchelor, a chartered financial planner at Progeny, said that despite increasing interest in annuities, they do remain a “niche product”.
He added: “It is certainly true that annuity rates represent better value for money than they did a few years ago, but this has also been accompanied by increasingly higher inflation. This means that unless a client selects an inflation-linked annuity, the real-terms value of the annuity that they purchase may be more quickly eroded over time.
“For people who have large pension funds relative to their needs and who are risk averse for example, buying an annuity now would provide a ‘copper-bottomed’ income at a better level then we have seen for several years. Not only that, but this income will continue to be paid for life, regardless of how long someone lives, so this could be a valuable guarantee that they could wish to take advantage of.
“On the other hand, the level of income available does not change the fundamental nature of annuities. Someone must still extinguish their pension fund in order to buy one, compared to the greater choice offered by drawdown. It is also the case that unless someone purchases an inflation-linked annuity, the real-terms value of the income provided will erode over time. The level of starting income that these inflation-linked products offer, however, is noticeably lower than standard annuities.
“This means that for those people who wish to buy an annuity, the choice is between a lower level of starting income that is protected against inflation in the future or a higher level of starting income that will gradually lose its purchasing power.
“It does not have to be an either/or situation, however, and for some clients, particularly those who do not have access to a defined-benefit pension, there can be logic in buying an annuity that will cover a portion of total living costs, such as basic living costs only, and leaving the remaining pension fund in drawdown.
“This can help to relieve anxiety about meeting essential living costs while allowing the residual unspent funds to remain invested, which then have the potential to achieve long-term, compound growth.”
