Annuities used to be what you lived on when you retired. People worked until they retired and for those people who had built up a pension pot, the pension provider then took all the money that had built up, and in return provided an annuity, which provided a guaranteed income for life. The actual income paid would depend on the annuity rate being offered, which itself largely depended on the yield on government bonds or “gilts” at the time the annuity was arranged.
The larger your pension pot, the larger the annuity and hence your retirement income might be. But things were complicated by the fact that annuity rates could go up and down. If high gilt yields dictated a high annuity when you retired, you might be very pleased with the pension income yours provided. If they were low, you might be more than a little resentful, but there was very little that you could do about it.
The income provided by a basic or ‘level’ Annuity is fixed when it is set up. This can cause another problem. The income which seems so generous on the day you collect your gold watch can seem pitifully small after 30 years of inflation push up the cost of living
Annuities fell rapidly out of favour after the Government abolished the obligation to buy one when pension freedoms were introduced in April 2015.
These reforms left you free to take cash from your pension from age 55 in the way that suited you. As a result, many people now prefer to leave their money invested which hopefully may continue to grow in value. They then draw down the money they need as they need it, in a process known, logically enough, as drawdown.
But there might still be a case for annuities, and the case may be getting stronger.
Why choose an annuity?
Drawdown can and does work well for many people. With a large enough pension pot, and a cautious approach to spending, it may be possible to live purely on the income generated by your pension savings.
With luck and good investment, you could actually see your pension pot continue to grow.
But there are no guarantees, and rising inflation and potentially the cost of care to consider it is possible to run out of money – particularly if you find that you are living rather longer than you had anticipated.
There is another worry with drawdown. It also exposes you to stock market volatility, and the potential for a pension destroying crash if your investments are not very carefully arranged.
With an annuity, there are no such risks. The annuity income will continue to roll in for as long as you live.
There are also alternatives to the basic annuity.
The level annuity pays out the same fixed of income for the rest of your days. This means zero protection against inflation. An “inflation-linked annuity” starts off with a much smaller income but keeps increasing over time. However, the starting income for an annuity that increases by 3% each year could be up to a third lower when compared to a level annuity payment option. Many people prefer not to have to wait and choose level annuities simply because they pay out more cash from the beginning.
A joint annuity can go on providing for a spouse after the original policyholder dies. This is a better choice for many couples where one partner does not have a pension of their own – although again there will be a reduced monthly payment.
What is happening now?
For several years, annuity rates have been so dire that many pensioners would not live long enough to get the value of their pension pot back in income.
In the aftermath of the financial crisis, a 65 year old with £100,000 of pension savings might get level annuity income of just £4,500 or so a year, and even less if they needed it to grow with inflation.
Now, with rising interest rates, annuity rates are starting to lift off from their rock bottom lows, and providers say demand for annuities is starting to recover.
However, many approaching pension time remain suspicious. Annuities may offer security, but they might still be a better deal for providers than for pensioners. Those in poor health risk getting the worst deal of all if they die shortly after taking out their annuity plan.
What should you do?
You could leave some of your pension pot invested via drawdown, allowing it to grow, and use the rest to buy an annuity to provide a secure lifetime income.
So, should you face your future with drawdown, or should you look at the potentially greater security of an annuity? Any decision will come down to your personal circumstances, and attitude to risk. A call to us at Continuum for some expert advice could help you find the answers that are right for you.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable retirement strategy, you should seek independent financial advice before embarking on any course of action.
Accessing pension benefits early is not suitable for everyone and may impact on the level of income in retirement also may affect your entitlement to certain means tested benefits.