Time to take annuities seriously

Annuities have always been a serious business* but since the introduction of pension freedoms in 2015 most retirees (and advisers) have not taken annuities seriously and many invested in pension drawdown rather than purchase an annuity.

Annuities have been unpopular for three reasons:

• The income from annuities has been very low
• Annuities have no flexibility so the alternatives appear more attractive
• On death, there may not be anything to leave to the family

I have been advising clients about their annuity options for over 25 years and I too have not taken annuities seriously for the last 10 years because the since the credit crunch in 2008 rates have been so low, but I really believe that it is time to take annuities seriously again.

Three things have happened in 2022 to make annuities more attractive:

• The income from annuities has increased significantly
• Recent stock market falls have made pension drawdown less attractive
• In an uncertain world many people want peace of mind and financial security

Before I explain why annuities should be back in fashion it will be helpful to recap on some basic retirement income principals.

When it is time to convert a pension pot into a regular income (after the age of 55 and probably after taking the 25% tax-free cash) there are basically two ways of doing this:

• An annuity policy – exchanging the pension pot for guaranteed income for life
• A pension drawdown plan – taking regular or ad hoc income withdrawals directly from the pension pot

I use the term ‘annuity policy’ because an annuity can be thought of as a type of insurance policy which guarantees income for life. Pension drawdown is a simply the option to keep investing in the stock market and to take income direct from the fund. This means that an annuity pays a guaranteed income no matter how long the annuitant lives whereas with pension drawdown the income is not guaranteed and it is possible to run out of income.

These explanations may be simple, but the decision whether to purchase an annuity or invest in pension drawdown is one of the most difficult personal finance decisions, especially now interest rates are higher and the stock market is more volatile.

Why annuities should be taken seriously

The short answer is now (July 2020) annuity rates have risen to a level that makes them much better value than at any time in recent years. This not only means that annuitants can get a higher income now but, in many cases, especially where peace of mind and financial security are important, annuities may be a better option than pension drawdown.

A longer answer is that annuities are the only policy that can pay a guaranteed income from life no matter how long that is.

When rates were lower, the alternatives to annuities such as pension drawdown seemed more attractive, but now annuity rates are high they are once again a hard act to beat and in many cases may be a better option than pension drawdown.

Annuities give peace of mind and financial security and this is something everyone in retirement wants even if they can’t properly articulate it.

“An annuity is a very serious business; it comes over and over every year, and there is no getting rid of it”. Jane Austen in Sense and Sensibility.