When George Osborne overhauled the pension rules in 2015, it was one of the biggest changes to the pension landscape in 100 years. The pension reforms ended the remaining restrictions that forced many people to buy an annuity with their pension pot.
The demise of annuities was widely predicted as a result because they had been criticised for lack of flexibility and poor value.
However, while sales of annuities have plummeted, with only about 12% of people hitting retirement today buying one, they can still play a valuable role in retirement income planning and should not be overlooked.
What is an annuity?
An annuity is a guaranteed income that is purchased with the value of your pension fund. Various options can be added to the annuity to meet your exact needs, such as yearly increases and an income for your spouse or dependent following your death.
The amount of income provided by an annuity depends primarily on how much you pay for it and your life expectancy - and here is where they can really add value. Research has shown that most people underestimate how long they will live, and therefore risk running out of money later in retirement.
A lifetime annuity ensures that you’ll always receive a regular income, thereby allowing you to budget effectively throughout retirement. The peace of mind that an annuity can provide can be invaluable. Yet because people are generally pessimistic about how long they will live, they often see annuities as poor value and are reluctant to buy them.
The truth is that the overwhelming body of evidence suggests they may indeed be the best investment, at least for part of your pension pot.
Annuities do have downsides, but professional advice can ensure you make the best choice.
The main alternative to an annuity, which has become much more popular since the pension reforms, is income drawdown. This involves leaving your pension pot invested whilst drawing down an income as and when you need it. Income drawdown is an excellent option for some people because it is very flexible and gives your investments the chance to continue to grow.
However, if the investments perform poorly or you live longer than you anticipated, there is a risk that your pension fund could be depleted within your lifetime. The volatility of remaining invested in the stock-markets in retirement can also be stressful for some.
Who should consider an annuity?
Those with a low risk tolerance. For people who do not like to take risks, or do not have the capacity to accept investment risk when it comes to retirement income planning, an annuity is well worth considering.
Those with health conditions or lifestyle factors that impact their health. Annuity providers will offer higher rates for people who are perceived to have a shorter life expectancy.
Those who want to add an element of security to top up the money they receive from an income drawdown plan, or on top of their State Pension.
“For those who don’t like the ups and downs of the stock market and who want certainty of income, annuities have a valuable role to play” said Barry Plummer, specialist in financial planning operations at Brewin Dolphin.
“If you are arriving at retirement and want to know that your fixed costs such as bills and other living expenses are definitely covered, an annuity can be a good option and is certainly worth discussing.”
For example, a lifetime annuity will provide a guaranteed income for life in exchange for a lump sum payment from your pension fund. If you live beyond your life expectancy the annuity provider will continue to pay your income, which is good news. The “trade off” is that if you die early, the annuity provider will keep the money that you paid them.
However, it is possible to add an income guarantee, or a beneficiary’s pension, to ensure that your family will continue to receive payments even after you die. Alternatively, adding capital protection allows you to protect up to 100% of your pension fund, so that if you die before receiving the full amount that you paid for the annuity, the provider will pay the balance to your beneficiary. The trade-off for adding the capital protection is that the amount of annuity your fund purchases at the outset would be lower.
Annuities may be less popular than they were, but they should not be ignored altogether, and should definitely be considered as part of your retirement planning.
The value of investments can fall and you may get back less than you invested.
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