In the bad old days before George Osborne became Chancellor, an annuity was pretty much the only way to convert your pension pot into an income. You gave your money to a provider, and in return they would provide you with an income for life. There were different flavours of annuity – in return for a lower initial income you could buy one that was index linked or one that would pay out to your spouse, and you could get a higher income if you suffered from ill health.
But with the new drawdown rules, annuities, whilst still available have rather gone out of fashion. Their attractiveness, or lack of, has not been helped by the historically low levels of annuity income you will currently receive from your pension pot, and which of course you will be stuck with for the rest of your life. Whilst there is some indication that annuity rates will rise by a couple of percent as the economy continues to recover, they are unlikely to return to the high levels of the early 1990s when a pension fund of £100,000 would have guaranteed an income of £15,640 a year for life. In May 2015 it would have provided less than £6,000!
Legal & General expect the UK annuity market to shrink in size from £12 billion to £2.8 billion following the introduction of the new pension rules, but this could also see providers developing more flexible and appropriate annuity products in the future for people considering flexible drawdown. After all, annuities may still have a part to play in your investment approach. If you read the section about your new options for managing your pension you will have seen two options for employing an annuity:
Mix and Match
This option entails splitting your pot in two to create an annuity that wil provide a regular and guaranteed income to cover your normal day to day living expenses in retirement, and a second pot which you could keep invested and which would hopefully deliver some capital growth.
Drawdown then Annuity
In this option you choose to put all your pot into drawdown initially, where you manage it until such time as it becomes too much for you, or you no longer want to dedicate the time to managing it. You then buy an annuity with the remaining pot. As you will be older, the income will be paid for a shorter period of time and so the income level will be higher. If by then you have acquired some age related medical issues you should also be able to secure an enhanced annuity rate, or what the providers call an impaired life annuity.
Shopping around is Crucial
Despite all the media coverage about the necessity to search the market for the best rates when buying an annuity, the level of inertia amongst those seeking an annuity has actually got worse. In the first Quarter of 2015, 62% of those who bought an annuity did so from their existing providers, up from 47% a year ago. With a difference of around 5% between the best and the worst rates, this can mean you losing out on £13,713 over a 25 year retirement.
However, if the proposals announced by the FCA in March 2015 do come into effect then providers will be required to share competitors’ rates with customers, helping overcome this issue for those that don’t have the benefit of financial advice. For a more detailed explanation of the issues and more useful data, have a look at the excellent report At Retirement from iress.
Annuity Buy-Back (updated 8th July 2015)
If you are already retired and are in receipt of an annuity you have the option of continuing with the annuity or at some stage in the future exchanging it for a lump sum under the Government’s buy-back proposals introduced after the first 2015 budget. The first Conservative Government budget of 8th July 2015 clarified that the Government was delaying plans to introduce a secondary annuity market from 2016 until 2017 amid concerns about the impact rushing the reforms could have on savers. It will set out further plans for introducing this measure in the autumn.
So, it looks as though this is going to be on hold for some time to come. We’ll see what the Chancellor has to say about it in his Autumn statement,