One of the biggest changes brought about by pension reforms is that savers are no longer required to buy an annuity. Instead they can take money out of their pots to use as they wish, subject to their rate of income tax. But annuities could still be relevant to some, says Alison Coleman
Annuities provide a guaranteed retirement income for life, but in recent years, due to a combination of low interest rates and longer lifespans, annuity rates have fallen, along with their popularity among retirees.
With a wealth of investment choice at their disposal, those with access to their pension savings may not give annuities a second thought, especially in light of the fact that just after the pension freedoms came into force, standard annuity rates reached all-time lows, according to Moneyfacts.
Figures from the financial website suggest that the average annual income payable on a typical single life annuity for a 65-year-old with a £10,000 pension pot has fallen by 5.9 per cent since the start of 2015. For those with a £50,000 pension pot, the decline was 6.4 per cent.
However, annuities could still be relevant to some, for example those with smaller pensions, or people who want a basic income to cover their household bills. Some may simply want the reassurance of knowing they have an income that will last as long as they do.
Higher value annuities
There are ways of improving the value of an annuity. One is to explore the option of an enhanced annuity. These are typically offered to individuals suffering from a health condition associated with a lower life expectancy, and as a result, rates tend to be higher.
Delaying purchase for a few years – which means the annuity won’t have to last as long – could be another option. Instead of tying themselves into a low-return annuity at age 55, some people may decide to wait until they are 65 or 70, which could make a significant difference to their retirement income.
For those people already with an annuity, there will be opportunities to sell it if they can find a buyer, something that a quarter of retirees are looking to do, according to a Which? Money survey.
More than two thirds (70 per cent) said they wanted to get rid of their annuity because they had been forced to buy one, while almost half (45 per cent) would want their entire remaining fund back if they were to go ahead and sell up.
Last year the government announced proposals to give existing retirees with an annuity the chance to enjoy the same pension freedoms as those yet to retire. It is now consulting on the creation of a second-hand annuity market, where third parties could buy an annuity and receive the income from it for the rest of the seller’s life, paying a lump sum to the person selling the annuity in return.
From April 2016, the 5.5 million people already taking an income from their pension will have the freedom to use that capital as they want, either taking it as a lump sum, or placing it into drawdown and using it more gradually.
In some circumstances it is possible to sell an annuity now, however this currently incurs a 55 per cent tax charge, rising in some cases to 70 per cent. Under the new annuity selling scheme this charge would be removed, so people are taxed only at their marginal rate.
Taking expert advice
Some experts insist that the UK market remains well suited to annuitisation. The Pensions Policy Institute, an influential think-tank, says factors such as tiered tax rates, a relatively low state pension, the existence of free healthcare through the NHS, and a sophisticated annuity market means it could be an advantage to securing a regular income.
Nevertheless, the news that pension annuity rates have hit an all-time low can only add to the confusion and concern that many people will now have around their post-pension freedom retirement plans.
“It is particularly unfortunate for those who may have deferred making a choice until the introduction of the pension freedoms but since decided that an annuity is still the most suitable product for them,” said Richard Eagling, head of pensions at Moneyfacts.
What it does emphasise is the importance of getting maximum value from pension savings. That means taking expert professional financial advice, carrying out thorough research of the market, comparing rates and quotes, and factoring in any lifestyle or health issues that could mean eligibility for an enhanced annuity.
In spite of the freedom of choice around pensions, nothing else provides the security of an annuity, which is why many retirees are expected to stick with one, or, depending on the size of their pension pots, combine an annuity with a portfolio of funds and alternative investments that carry a higher level of risk.