Since the financial crash of 2008, annuity rates have been what can only charitably be described as low. This climate, combined with the complications and lack of clarity involved in buying an annuity, has locked tens of thousands of pensioners into struggling on a far lower retirement income than they need to.
What’s wrong with annuities?
There’s nothing inherently wrong with annuities. And for most people, particularly with smaller pots, they remain the best option. The problem is twofold.
Firstly, rates have become incredibly low in the current economic climate. This is predominantly due to yields on gilts (government bonds) being low. By and large, insurance companies provide lifetime annuities by sticking your pension pot into bonds – and gilts in particular – for a modest but near-guaranteed return. If yields are low, so are annuities.
But it’s also because insurance companies have become more timid in light of the financial crash. They got wise to how badly, and how quickly, they can be affected by market crashes, and how challenging maintaining their generous payment obligations made in the booming 80s can be.
Secondly, annuities are probably the trickiest financial product available. Once you commit, you’re in it for the rest of your life. Meanwhile, the rules and regulations surrounding them are incredibly complex, making shopping around very difficult. Many people end up being shepherded into the easiest option, which could generate a significantly lower income than a different supplier, or even one of the alternatives outlined below.
Until 2011, retirees were required to buy an annuity by the time they reached the age of 75. This requirement has since been rescinded. Provided you meet the relevant criteria, you can now utilise the process of ‘income drawdown’ for your entire retirement.
This means leaving your pension pot invested and drawing your income directly from it at a maximum value of 120% of a comparable annuity (this is to prevent you from prematurely spending down your retirement fund and having to fall back on state benefits).
It’s riskier, of course, as stocks and bonds can go down as well as up – and you don’t have the safety of a guaranteed income level like you do with an annuity – but you can end up with a higher level of income. And you could even grow your pot. At the very least, income drawdown may be worth considering while you wait for annuity rates to improve.
Generally speaking, due to both regulations and simple common sense, drawdown does require a larger pot, so it’s worth planning ahead for this option to see how much you need to put aside to make it viable.
Another alternative is a sort of ‘mix and match’ approach. A phased retirement could involve spreading your retirement fund between a number of assets. For example, you could put part of your pot into a fixed annuity for five years, leaving the rest invested, and then see where you are when the fixed annuity runs out – possibly doing the same thing again, or taking the plunge with a lifetime annuity.
Using this approach you can take a 25% tax-free lump sum at each stage, so you gain a lot of extra flexibility. This could be particularly useful at if you’re due to retire now, so you can spread your fund in a far more advantageous way than going straight to a lifetime annuity – waiting for market conditions to become more favourable.
If you plan far enough ahead, you could of course sidestep pensions altogether – an increasingly popular option in light of the trouble with annuities and the near-constant changing of pension rules.
If you build up a large enough fund, and are disciplined as to how much income you draw from that, it’s entirely possible to fund a pension-free retirement. For example, using your entire Isa allowance each year can build a hefty nest egg, which can then be put into a spread of other investments that provide a regular income once you do retire.
You could get into buy-to-let for monthly rent. Or you could mimic what happens to pension funds anyway and invest in bonds. Or continue with a more diversified portfolio and aim to grow your fund through riskier investments alongside safer options.
This option does require a sizeable amount of capital, so is not something to consider if you’re nearing retirement already. And naturally, it is riskier than a pension, less tax-efficient and requires more active management – so is best avoided if you’d rather not think about it. But it does offer you more control, less subject to the vagaries of Chancellors, and the opportunity for greater reward.
Whatever you do, if you have a sizeable retirement fund – in pensions, Isas, or other investments – it’s probably worth seeking professional advice. Annuities for life are an increasingly unattractive path. You may well be able to achieve a significantly higher income – and therefore quality of life – by pursuing other options.