Annuities - A Thing Of The Past?
For those who value the prospect of a good night’s sleep in retirement, an annuity is the only financial product that will offer the certainty of a secure income in later life.
Money saved in a pension plan is given to an insurer, who turns the lump sum into a guaranteed lifetime income for the policyholder and any spouses attached to the contract. The concept of paying out a flow, or stream, of income to a person or even a family dates from the Roman empire. The annuity concept has survived throughout the centuries and, today, an estimated 6m policies are providing a regular income to retirees throughout the UK.
But in spite of the peace of mind the policies can offer, annuities have fallen out of favour. The first quarter of this year saw a dramatic drop in annuity sales, with only 20,000 policies taken out compared with 70,000 the same time a year ago, according to the Association of British Insurers (ABI), the trade body. This development followed big reforms, which removed the requirement for people to buy an annuity at retirement. While many savers are exploring new ways to spend their pension pots, such as treating themselves to cars, holidays or keeping their money invested in “drawdown”, advisers say annuities still have a role to play in a retirement strategy.
With an annuity, the rate offered in exchange for a lump sum is determined by a number of factors, including the policyholder’s age, where they live (used by insurers as a proxy for life expectancy), the size of their fund and their health. Annuity rates are also sensitive to movements in interest rates. Whether the annuity income is “joint life” or continues to pay to a spouse, or has a money-back guarantee attached, or rises with inflation, will also influence the rate offered to the principal policyholder. A 65-year-old man buying an annuity today, with a £100,000 pension fund, which carried a five-year money back guarantee and no tax-free cash, could expect an annual income of about £5,500. However, he would need to live at least 19 years to break even on his capital.
Pension experts say those looking for an annuity could boost their retirement income in a number of ways. Annuities become better value the older you are, so if you are below the age of 65, in good health and have a decent sized pension fund it might be better to delay your annuity purchase until you are older if you can take income in another way, for instance through income drawdown.