The trouble with annuities
The turbulent markets make buying an annuity a tricky proposition and getting it wrong could mean losing thousands in the long term.
Recent market volatility has made the decision of how or when to annuitise even more tricky.
For pension savers invested to any extent in equities, the market gyrations seen over the summer will have played havoc with their fund values.
But, equally, falling gilt yields will have put further downward pressure on annuity rates.
The latest figures from Alexander Forbes Annuity Bureau show annuity rates generally holding steady during August but the company says it expects to see rates come down a bit further in future.
The best rate available for a level annuity for a male aged 60 remains Aviva offering an income of £6,120 a year on a fund of £100,000. However, the second-best value from Canada Life fell by £35 a year to £5,842 and the company expects several other companies to follow suit.
Alexander Forbes Annuity Bureau head of operations Gemma Goodman says: “August was an interesting month for annuity rates, with falls from Canada Life, while other providers kept rates fairly static. At the same time, we hear from the Office of National Statistics that Britain’s population is living longer, with the number of people living beyond 100 predicted to rise to more than half a million in less than 50 years.
“These changing demographics will undoubtedly mean a long-term downward trend in annuity rates while also placing further pressure on state pension provision.
Individuals off all ages need to plan carefully how they will fund their lifestyles post-retirement as income in older age will continue to be major concern not only for those retiring in the near future but also the generations to follow.”
The difficulty in planning how to fund retirement is a stark choice between crystallising any investment falls incurred but then locking into the security of a conventional lifetime annuity or opting for drawdown or an investment-linked annuity to try and recover some of the value over time.
Barnett Waddingham consultant Malcolm McLean says: “Now is an unprecedentedly difficult time for people who are approaching retirement and are looking to buy an annuity from their pension pot. Because of stockmarket volatility and falling gilt yields, both fund values and annuities have reduced considerably over recent weeks, with the likelihood of annuity rates heading down even lower in the coming weeks and months.”MGM Advantage pensions technical manager Andrew Tully says despite the appeal of guaranteed income, market volatility and falling fund values makes this a bad time for anyone retiring to lock into a conventional annuity.
Tully says: “People should not make long-term financial decisions based on short-term circumstances. While it may seem safe to use a conventional annuity where there is no investment risk, this is likely to be the wrong time to lock into a conventional annuity as it gives people no chance of recouping recent investment losses.
“With conventional rates at their lowest for many years and rising inflation meaning many pensioners are struggling to survive financially, taking a fixed income for life with no future potential for investment growth will have little relevance for many pensioners.”
McClean has some sympathy for this point of view and says: “Some experts are advising that people in this situation should not hang around and should settle for their annuity purchase as soon as possible in anticipation of further falls.
But there is an equally compelling argument for delaying the purchase where possible for as long as necessary in the hope and anticipation that the position will stabilise and annuity rates will eventually return to something like their former value.”
The prospect of inflation remaining high over the short to medium term adds another potential headache to the mix, with pensioners choosing a level annuity leaving themselves exposed to the erosion of their income.
Figures from Prudential suggest that pensioners could see up to 60 per cent of the value of a level annuity eroded by inflation over 20 years.
Prudential head of business development Vince Hughes-Smith says: “Pensioners on a fixed income are particularly vulnerable when it comes to rising living costs.
“There are alternatives to a fixed income in retirement, for example, choosing a flexible income plan that has the potential to grow could help many retirees to mitigate the effects of increasing living costs.”
One upside to the volatility is that IFAs could see a boost to the demand for their advice.
McClean says: “It is notoriously difficult, of course, to time the market and it is more important than ever in the present financial climate to seek professional advice before final decisions and commitments are made.”
But this means that the responsibility for getting the tricky decision right now rests with the adviser.
As McClean says: “Getting it wrong could mean losses of thousands of pounds of income over the course of even an average retirement.”