The retirement market has changed substantially over the last 18 months since the pension freedom changes. More money is now going into drawdown than annuities, rates have been hit by Solvency II and lower gilt yields, and we have seen several providers pull out of the annuity market. So does this spell the beginning of the end for the humble annuity?
There is no doubt many people love the flexibility and control the pension freedom changes have brought. And that has driven the position where drawdown sales now exceed annuities. But, equally, there are many people who desire some certainty. The comfort that no matter what happens, some income will appear in their bank account each month to cover their essential outgoings. And more than 80,000 people will put more than £4 billion into annuities this year – despite the pull of pension freedom and the low rates currently available.
When we bear in mind that most smaller pots below £30,000 are now being withdrawn as cash, it shows annuities are continuing to be a key option for many people in the ‘middle market’ with pension pots of between £30,000 and £250,000. And that feels right. Some people simply don’t like to take risk. Our latest research* from August tells us 29% of people approaching retirement want to take no risk with their pension savings. The only sensible option for these people is some form of guaranteed income for life. Others may well want or need some element of certainty while retaining flexibility with the remainder of their savings.
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It’s also worth remembering that annuities had a bit of a makeover as a result of pension freedom. That has allowed providers to fix one of the traditional key objections to annuities – the benefits paid on death. Historically if people died shortly after buying an annuity their family lost out. Now with much greater death benefits available, such as 30-year income guarantees and lump sum money-back guarantees, people can be sure that no matter what happens their family will get full value from their pension savings.
Another problem with a traditional annuity is the lack of flexibility around income. Customer circumstances are likely to change as they go through retirement and so their income needs will vary. The new hybrid solutions which hold an annuity within a drawdown wrapper get around that problem. The customer can choose each month how much of their income to withdraw and how much to leave to build up in the drawdown for use at a later date. Or, in other words, a fully flexible annuity income that allows you to help your clients with tax planning and to vary income to meet their changing needs.
The hybrid also allows much more flexibility over the payment of death benefits, allowing you to help your customers to control the tax paid and cascade benefits tax-efficiently to their family after they die.
That leaves the elephant in the room of annuity rates. These fell early in the year due to the impact of the Solvency II rules which force providers to hold greater capital reserves. It has taken much of the year for many providers to agree individual arrangements with the regulator to determine exactly how much capital needs to be held. So as we move into 2017 that should be less of a constraint to business. Gilt yields also fell markedly in the aftermath of the vote to leave the EU and, as a result, annuity rates fell through July and August. However there have been a number of increases over the last couple of months with rates up nearly 11% since August and average rates are 5.18%, back up above that 5% threshold where many feel they need to be to make an annuity a more attractive proposition**.
While we won’t return to the world before pension freedom when 80% and more of money went to annuities, they remain a key option at retirement. In simple terms there must be a future for annuities because they meet a key customer need – the certainty of an income throughout retirement no matter how long people live and not dependent on the vagaries of the stock market. And crucially it doesn’t need to be an annuity versus a drawdown decision, the two options can simply and easily be used in tandem to give customers the best of both worlds.
* Research conducted by YouGov plc for Retirement Advantage between 15/8/16 and 19/8/16
** Retirement Advantage based on data supplied by Investment Life and Pensions Moneyfacts at 30 November 2016