Love them or loathe them, annuities are here to stay and we need to consider their merits in financial planning.
Interest rates are at an all-time historical low – and Mark Carney, the Governor of the Bank of England has recently announced a new policy initiative which is likely to see them stay low for some time (his Forward Guidance programme).
Interest rates are one of the key determinants of annuity rates, so it looks like those rates will also stay low for some time to come. Does this mean that annuities will fall further out of favour?
Will yet more products be introduced to provide alternative retirement solutions? Or will the conventional annuity remain a viable option for those clients who need to plan their income in retirement?
A conventional annuity is very simply an income for the rest of your life, which you ‘purchase’ with some, or all, of the money you’ve accumulated in your pension fund throughout your working life. There are some variables you can build in to an annuity, of which the most common are an income for a spouse and the option to have your income from the annuity increased each year, but the basic concept is straightforward.
In this article we’ve taken a look at the advantages and disadvantages of the annuity, to see if it still has a place in clients’ financial planning at retirement.
The Advantages of an Annuity
There are perhaps five main advantages of an annuity. These are:
- An annuity is simple: if you want your financial planning to be straightforward and easily understood, then an annuity has a lot to recommend it
- An annuity is secure: once your annuity contract is in place and the level of income determined, then that level of income will be paid to you on a regular basis
- The income from an annuity is guaranteed for life: there is no danger of the ‘money running out’ at some point in the future
- There is no investment risk with an annuity: whatever happens with world stock markets and interest rates, your annuity will not be affected
- Finally, there is now the option to protect your capital using Pension Annuity Protection. Clients traditionally worried about ‘losing’ their capital if they died shortly after purchasing an annuity – Pension Annuity Protection goes some way towards removing that worry.
The Disadvantages of an Annuity
As you might expect, the advantages of an annuity are balanced by an equal number of disadvantages, most of them based on the fact that an annuity is a very inflexible form of financial planning:
- Once you have chosen your income from an annuity it cannot be changed, irrespective of any changes in your personal circumstances
- All the decisions relating to an annuity – how much income you want, whether or not that income will increase in payment and so on – must be taken at the outset. Again, there’s no scope for altering these decisions in the light of changing circumstances
- Although Pension Annuity Protection allows you to protect your capital to some degree, it may incur a 55% tax charge on death (assuming the person concerned died after 6th April 2011)
- Once you have bought a conventional annuity you can no longer benefit from investment growth: if stock markets rise dramatically it will not impact on your annuity
- And as we’ve seen over recent years, if you buy an annuity when interest rates are low then annuity rates will also be low, which will impact on the income you will receive.
So, there are clearly advantages and disadvantages around the purchase of an annuity.
The good news (or the daunting news, depending on how you see it) is that there are now many different options for those looking to start drawing an income from their pension pots to consider. Income Drawdown, Phased Income Drawdown, Enhanced or Impaired Life Annuities, Fixed Annuities, Lifetime Annuities and Scheme Pension all potentially have a part to play in generating an income in retirement.
As with all financial planning, it is essential that you make the right decisions for your particular position. It is therefore an area that needs careful consideration and we’re more than happy to talk through your options with you at any time.