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Billy Burrows: Solving the annuity puzzle

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When I think back 10 years or more, I am sure we were using more sophisticated  arguments to explain the benefits of annuities, compared to recent years when the message was almost entirely focused on shopping around for the best rate. 

So I was pleased to come across some presentations I did many moons ago. One was a presentation I gave to the Personal Finance Society in 2008, which included a few quotes from a US paper on annuities called “Annuitisation – it shouldn’t be a secret”, written for the National Association of Variable Annuities.

In the US, most people with above average sized funds use a form of drawdown called “systematic withdrawals” but very few people purchase lifetime income policies despite the benefits. However, US economists refer to the annuity puzzle; if annuities provide the most efficient way to pay income for life, why don’t more people buy them?

The NAVA paper put forward some powerful arguments why people should take annuitisation more seriously and made the following observations about the concerns and needs of many older investors:

  •  Concern for lifetime income and risk of outliving their financial asset
  • A strong desire to preserve one’s standard of living in the long-term
  • A desire for professional asset management
  • The need of many older individuals for simplicity and structure in their financial affairs
  • Coming to grips with their own mortality and expressing concern about the desire or ability of a surviving spouse to manage money in the event of their own death
  • The only way to combine income for life with professional asset management, and simplicity and structure, is through a guaranteed or investment-linked annuity.
  • One of the often quoted advantages of drawdown is the lump sum death benefit even though there is 55 per cent tax charge. However, if the NAVA was right, many people place a high priority on their partners being left without money worries and this is the benefit of a joint life annuity.
  • The paper also considered some of the reasons why most people ignore annuities. These included:
  • Benefits of annuitisation are not sufficiently emphasised
  • Desire for flexibility, control and death benefits
  • The belief that the same goals can be achieved by a systematic withdrawal from a mutual fund

I do think annuity providers were guilty of concentrating on price not quality. But at a time when everybody in the UK will soon have freedom to take their income how they wish, it is important to reflect on the dangers of believing that taking a pension as cash, or by way of drawdown, is better than purchasing an annuity. 

Best Buy annuity tables – £100,000 purchase
Conventional – Single life, G’tee 5 Years 55 60 65 70 75
Hodge Life £4,867 £5,399 £6,039 £6,835 £7,943
Legal & General £4,896 £5,374 £5,940 £6,449  
Canada Life £4,964 £5,362 £5,982 £6,764 £7,898
Aviva £4,910 £5,343 £5,941 £6,555 £7,623
Increasing in line with RPI 55 60 65 70 75
Aviva £2,469 £2,931 £3,542 £4,254 £5,369
Legal & General £2,452 £2,918 £3,447 £4,061  
Canada Life £2,322 £2,754 £3,379 £4,189 £5,350
Prudential £2,229 £2,707 £3,414 £4,368 £5,809
Conventional – Joint life 2/3rds, G’tee 5 Years, level 55 / 50 60 / 55 65/ 60 70 / 65 75 / 70
Hodge Life £4,502 £4,908 £5,365 £5,913 £6,680
Canada Life £4,571 £4,879 £5,285 £5,857 £6,672
Legal & General £4,431 £4,838 £5,235 £5,614  
Aviva £4,433 £4,786 £5,177 £5,547 £6,259
Increasing in line with RPI 55 / 50 60 / 55 65/ 60 70 / 65 75 / 70
Hodge Life £4,502 £4,908 £5,365 £5,913 £6,680
Canada Life £4,571 £4,879 £5,285 £5,857 £6,672
Legal & General £4,431 £4,838 £5,235 £5,614  
Aviva £4,433 £4,786 £5,177 £5,547 £6,259
With-profits – Single life, G’tee 5 Years 60 – 0% RFP1 60 – 4% RFP1   65 – 0% RFP1 65 – 4% RFP1
LV= £3,319.00 £5,725.00   £3,960.00 £6,344.00
MGM £3,002.40 £5,533.80   £3,595.68 £6,116.04
Prudential £2,912.76 £5,403.48   £3,453.72 £5,915.28
Fixed Term – Single life, G’tee 5 Years 60 – Income2 GMV3 – 5 yrs   65 – Income2 GMV3 – 5 yrs
Primetime £5,300.00 £85,512.00   £5,900.00 £82,264.00
Just Retirement £5,291.00 £85,328.00   £5,798.00 £82,702.00
LV= £5,078.00 £85,748.00   £5,566.00 £83,192.00
Drawdown income – Current yield = 3% 55 60 65 70 75
150% GAD £7,200.0 £7,950.0 £8,850.0 £10,350.0 £12,450.0
100% GAD £4,800 £5,300 £5,900 £6,900 £8,300
Notes: 1RFP = Required Fund Perfromance – 2Provider calculated rate – 3GMV = Guaranteed maturity value
MM Graph 100714 p37

Annuity update
There is still no sign of significant activity in the annuity market as bond yields remain stable. The yield on 15-year gilts has remained stubbornly still over the last three months as the yield at the beginning of the month for May, June and July was 3.14 per cent,  3.11 per cent and 3.16 per cent respectively. Consequently there has been little movement in annuity rates. Summer is traditionally a quiet period for annuities and this summer will probably be no exception. However this inactivity cannot go on forever especially as Bank of England governor Mark Carney is forecasting that interest rates will increase in the future. He has suggested the “new normal” for interest rates is likely to be about 2.5 per cent when rates start to increase. They could reach this level in early 2017 but any increases in rates will be slow and gradual. However when considering the future trend for annuity rates it is important to distinguish between short-term and long-term interest rates. It may be the case that short-term rates will increase and so mortgage payments will increase but longer-term rates and annuity rates will increase more slowly. The message remains the same; expect long-term yields and annuity rates to rise in the future but it will be a slow and gradual process.

Billy Burrows is associate director at Key Retirement Solutions and director at Retirement Intelligence 

 

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