What a state the annuity market is in. Rates are still at low levels, we have had a disappointing outcome from the FCA’s enhanced annuity review and now a U-turn on the secondary market.
The demise of the annuity was signalled back in 2014 when then-chancellor George Osborne delivered his infamous Budget speech. However, the seeds of discontent were sown in the years before, with the growth in non-advised annuity sales. I could tell a tale or two about some of the sharp practices I saw but I will leave that to another day.
In order to consider the future for annuities it is necessary to look at three key issues.
Value for money
It is difficult but we must separate value for money from low returns. Annuities provide good value for money in that they pay back capital and interest over the life of the policyholder.
This “optimum distribution of income” is achieved through mortality cross subsidy, where those who die early subsidise the income of those who live longer than expected.
The problem is the underlying interest rate is so low at the moment. It just does not make sense to lock into an annuity. The returns will become attractive once again if interest rates rise and long-term yields go above 3 per cent – levels not seen since 2014.
Role in financial planning
Annuities are the only policies that guarantee income for life. However, just because someone wants a guaranteed income, it does not necessarily follow that an annuity is the answer. There are other ways of providing guaranteed income, albeit not for life.
Today’s retirement income needs are more complex than in the past because there are more options available. This manifests itself in the decision between income certainty and pension flexibility. Drawdown may be the new default but it is a much riskier option.
Blended solutions, which address the need to balance security and flexibility, are becoming more popular. As long as the retired need a base of secure income there will be a need for annuities.
Importance of advice
The decision between purchasing an annuity or investing in drawdown is made all the more dangerous without the right help or advice.
Many people are inclined to overlook annuities in favour of drawdown but it may not provide the best outcome if set up incorrectly. Advisers understand the sequence of returns risk and the need for a sustainable income drawdown rate, which is way beyond the knowledge of most people.
In conclusion, there must be a future for annuities because they meet an important financial need. But there are still too many negative forces acting against them. When these forces start to be become more positive – higher yields, more serious engagement with retirement income issues and more advice – the use of annuities will increase.
Billy Burrows is director of Retirement Intelligence