Why annuities are still relevant
First published 02 June 2014 • Updated 13 March 2018
Post-Budget, many are questioning whether they need to purchase an annuity. But Mark Brownridge explains why they’re still a highly-relevant option.
In his March Budget, George Osborne dropped a pensions bombshell by announcing that from April 2015, pensioners will have the freedom to cash in as much or as little of their pension pot as they want, removing the need to buy an annuity.
Almost immediately, this news sent the share prices of the traditional annuity providers nosediving as analysts predicted that up to a quarter of potential annuity sales were under threat.
“Actually, the purchase of an annuity has not been compulsory since April 2011”
For those who are considering accessing their pension pot, the announcement has left best laid plans in disarray and gives much to consider. Delaying retirement plans until after April gives access to the new rules and full flexibility, but many retirees won’t have that option: they’ll need income now. The challenge is to use the interim flexibility to find a solution that both meets this need and keeps the door to the coming flexibility open
So, what does all this mean for annuities and what has actually changed for anyone considering an annuity?
- Let’s be clear on the announcement that the proposals will “remove the need to buy an annuity”. The purchase of an annuity has not been compulsory since April 2011.
- Fundamentally nothing has changed. The fact of the matter is, that for anyone looking to secure a guaranteed income for the rest of their life, an annuity is still an appropriate, and valuable option – as the Chancellor took great care to point out.
But the impending 2015 changes mean a drawdown is no longer the reserve of the rich or sophisticated investor, and must now be considered for almost everyone wishing to access their pension pot, regardless of the value of their retirement savings. So, annuities will increasingly come under threat from drawdown. But as a consumer, is this a bad thing?
Whatever your retirement needs were before the Budget, these will not have changed, there are now just more choices available to meet those needs. The most likely outcome is that more people are likely to question their retirement options and will need advice from a whole of market financial adviser who understand the nuances involved in examining an individual’s circumstances and then making the best possible financial recommendation.
For many, however, the lure of taking their whole pension fund as a lump sum will be too tempting. Some investors will spend too quickly and face a fall in their standard of living later in retirement. Others might believe putting money in their bank account, or other conservative investments, is better than leaving it in their pension. This may mean they are ‘excessively conservative’ withdrawing less income than is sustainable, as they fear seeing their savings reduce in value.
And don’t forget, anyone who withdraws their pension fund savings fully, will be taxed at subject to their marginal tax rate. This is likely to represent an immediate reduction in the capital from which to generate an income stream, of 20 per cent (depending on their tax rate).
Annuities were and continue to be the only investment which provides an income, guaranteed, regardless of how long you live. Every other pension retirement income option relies on investments in fluctuating assets, which means there’s a risk that savings won’t perform as expected and income either falls or at worst runs out altogether. This gives annuities a strong advantage.
Working until you drop? No thanks
Income from a lifetime annuity dispels uncertainty; the peace of mind gained by knowing there will always be a regular income coming in is without comparison. Unless we work until we drop, we’ll likely have to find a way to replace the security of our working income with the security of a retirement income.
Apart from a well-constructed annuity solution, what other investment product, could a retiree achieve a perpetual, guaranteed income of approximately 5 per cent for a standard annuity or more for an enhanced annuity on their savings for the rest of their lives?
So annuities are here to stay, and for good reasons. There’s no doubt that annuities will have to change, evolve and offer new and different features going forward as annuity providers look to re-establish themselves but they remain an essential retirement income planning tool.
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About the author
Mark Brownridge heads up financial planning firm Mazars’ research and development team. His responsibilities include incorporating the research, development and implementation of systems to ensure the effective roll out of financial planning services and products.
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