There are many arguments for and against buying an annuity – the crucial thing is to talk it over with an expert
There are powerful arguments for and against the average person buying an annuity with their pension pot. In fact, the arguments are so powerful on both sides of the debate that you could easily get tennis neck switching between the two.
This really is a field where personal circumstances are hugely determinative as to whether annuities are a good thing or something to be avoided.
Which of course is another way of saying that getting advice from a competent wealth manager who will work through your personal goals, ambitions and circumstances is seriously important where a decision about annuities is concerned.
In general terms, how much of a return you will get from an annuity provider is massively impacted by what the Bank of England does with interest rates. In 2020, when interest rates were at 0.10 per cent you’d have barely got your money back plus a little spare change.
In June this year, a 65-year-old man could expect to secure an annual income of around £7,154 on a pot of £100,000. That is extremely decent and more than matches the returns that you would get from a good many alternative approaches to investing.
That said, we are not in June any more. In August, the Bank of England cut its base rate by 0.25 per cent, to 5.0 per cent. Annuity providers will have cut their offerings accordingly, but they will still be hugely attractive by comparison with the chump change you would have secured in 2020.
By the way, note how specific the above sentence is in detailing the fact that the amount cited is for a 65-year-old male in reasonable health and is a single-life annuity. (That means that when the man dies, the annuity payments cease instantly.) So, age and gender matter.
Your state of health matters, and of course, it matters whether you are buying a single-life annuity or want your spouse to continue to enjoy some benefit when you die.
If you want the annuity payments to survive the death of one partner in a marriage, you would buy a joint-life annuity.
In June this year a joint-life annuity that reduced the payment on the death of one of the partners by 50 per cent, would have netted you around £6,400 annually on £100,000. That sum would continue until one of the partners died. Thereafter, the remaining partner would be guaranteed half that amount until they died.
Notice that when both partners had departed this world, the annuity payments would cease and there would be nothing left of the annuity for any surviving grandchildren or other relations.
A guaranteed return of around 6 or 7 per cent, at a time of reasonably high interest rates, such as we are currently living through, is very attractive.
However, not being able to pass a pensions pot on to the next generation has long been one of the strongest arguments against going for an annuity.
That said, many people would consider that the positive point, namely that an annuity is a guaranteed, risk-free sum for life, irrespective of the vagaries of the marketplace, far outweighs the negative point that the payout vanishes on the death of the beneficiary or beneficiaries.
That this is true for very large numbers of retirees is more than borne out by the huge surge in sales that annuity providers have seen over the last two years.
Lorna Shah, managing director retail retirement, Legal & General Retail, points out that L&G experienced a record £1.4bn of annuity sales in 2023 and that momentum has continued, more or less unabated, into this year.
“It is a really complex decision to see what is the best option for an individual to see them through their whole retirement period.”
Lorna Shah
“The market is definitely growing. We are seeing annuity sales coming both through wealth management channels and direct from the public,” Shah says.
The evidence that many people are making their own decisions on annuities does have a slightly worrying edge to it.
As Shah notes: “Professional financial advice is so important in this kind of decision. It is a really complex decision to see what is the best option for an individual to see them through their whole retirement period.”
As a rough rule of thumb, she suggests, individuals should perhaps consider a basic annuity with part of their pension pot, to ensure that they have a stable minimum income through their retirement years.
Then they may want to supplement this with more aspirational investments once their old age is fully secured.
However, as this suggests, the decision as to how much the minimum income should be, and what the ‘aspirational investments’ should be, is seriously complicated. As many wealth managers know all too well, many people are relatively clueless as to how much income they will need in their retirement years.
It is only when they sit down with a skilled financial planner who can walk them through their goals and analyse their likely expenditure that they start to get a real feel for what they will need.
As Shah explains, L&G has a whole portfolio of annuity products and choosing the right one for a particular individual’s circumstances can be less than intuitive. For example, although the vast bulk of annuity products are either single or joint-life and cease on death, L&G offers an annuity that has death benefits attached.
“Some people are worried by the idea that if they die early on in their retirement the annuity is ‘wasted’. This product ensures that value is passed on to your estate,” she says.
Actually, of course, annuity providers would argue that the idea that the annuity is wasted if you die early is false. Their actuaries have factored in the statistical likelihood of a certain percentage of customers dying early, and those calculations go into determining the size of the annuity that you get.
So, some early deaths may well happen, but the rest of the retiree population benefits from a marginal increase in the payouts they get. It doesn’t help you or your estate, but them’s the breaks!
Of course the more bells and whistles you attach to an annuity the lower the value of the annual payout will be. So again, this is a balancing act that needs to be given serious consideration.
Roger Clarke, a chartered financial planner with wealth advisers The Private Office, points out that although annuities are now very much back on the public’s radar, as it were, they remain a very long way from being a ‘no-brainer’ decision.
“In 1979 a 60-year-old man could get an income for life of around £16,000 in exchange for £100,000 to the annuity provider. In 2022 that would have bought him just over £4,000, and in 2020, with rates at next to zero, he’d have got a pitiful sum,” Clarke says.
He points out that there is a reasonable likelihood that the 11.1 per cent inflation the UK experienced due to the disruption that followed Russia’s invasion of Ukraine is now fading.
The Bank of England has already cut interest rates and so it is probable – but not certain – that interest rates will continue to fall.
This means that some of the newly acquired shine might be coming off annuity products. Another point is that fixed-rate annuities do not protect your income if the UK moves into another period of high inflation.
You can buy index-linked annuities, but the initial payout you get is, again, at a significantly lower level than you would get now from a basic single-life annuity.
“For myself, I’m still kind of agnostic on annuities. There are definitely options that have a good chance of providing a higher rate of return. But, of course, there are risks attached. So much of the decision comes down to how risk-averse you are,” Clarke says.
L&G’s Shah points out that L&G’s own research finds that 29 per cent of respondents cite the fact that annuities are risk-free as the determining factor for them.