Annuities were once considered the bread and butter of retirement finance.
Indeed, it was standard practice for individuals who reached their desired retirement age to withdraw 25% of their pension as a tax-free lump sum and use the remaining 75% to purchase an annuity. And in doing so, their savings would be converted into an annual pension and a guaranteed income for life (or a pre-agreed period).
However, the introduction of the pension freedoms in 2015 shook up the system. Now Britons could not only access their pension at the age of 55, but they could explore alternative retirement finance options such as flexible drawdowns or even investments.
Consequently, annuities fell out of favour…
A less appealing option?
It is possible to see how annuities might struggle to compete with more flexible and potentially more lucrative retirement finance options.
For example, flexible drawdowns enable individuals to withdraw as much or as little income from their pension as they wish, whilst allowing what they don’t take out to remain invested. As such, the pot can continue to grow over time. An annuity does not allow for such flexibility; once their income figure is agreed upon, this cannot be changed.
Another factor one must consider is annuity rates, the percentage by which an individual’s annuity will grow each year. They are usually shown as how much money a person will get per £100,000 they pay to the annuity provider.
So, for example, an annuity rate of 5% would mean a retiree will get £5,000 for every £100,000 they invest; this would mean that paying an annuity provider £50,000 would result in receiving £2,500 each year.
Annuity rates are determined by numerous factors, including life expectancy, the health of an individual, the size of their pot, and interest rates. In recent years, annuity rates have not been particularly generous due to a combination of rock-bottom interest rates (which until recently sat at record lows of 0.1%) and the population’s longer life expectancy. As such, people may feel that they are getting less for their money with an annuity and instead look to other more lucrative forms of retirement income.
And such factors certainly spur the question; will annuities fade into obscurity?
A case for annuities
One could argue that annuities could still be a viable option for some people, given certain circumstances.
For example, interest rates are gradually beginning to rise again, which will spur an increase – albeit a modest one – in annuity rates. As such, annuities may begin to look like better value for money. From some people.
Additionally, in times of uncertainty, they can offer some welcome reassurances. For example, retirees may have most of their pension tied up in stocks and shares. As such, the value of their pension could fluctuate dramatically throughout periods of market volatility. Accordingly, it might be beneficial for such retirees to purchase a fixed-term annuity. This would guarantee them an income for a predetermined period of time whilst they wait for markets to stabilise and their pension investments to restore their value.
That said, annuities will not suit everyone’s personal circumstances. So, it is vital that individuals seek independent financial advice before making any final decisions. For example, My Pension Expert’s team of advisers will review a person’s financial situation, risk appetite, and retirement goals before making recommendations to help them achieve the best possible retirement outcome. For some, this may involve weaving a fixed-term annuity into their strategy, but it will depend on their personal circumstances.
Whilst annuities may no longer be a staple in Britons’ retirement strategies, they are still worthy of consideration. Indeed, the security of a fixed income in times of uncertainty could prove to be a valuable financial tool throughout retirement. As always, however, individuals should seek advice before making a final decision. In doing so, they will ensure that they achieve the financially comfortable retirement they deserve.