It used to be that almost everyone with a private pension fund bought annuities when they retired. But Pension Freedoms have changed that. Now nobody is forced into buying an annuity with their pension savings. Instead, drawdown has become far more popular. The main reason for this has been the dramatic fall in annuity rates.
Many retirees refuse to even consider buying annuities, now or in the future. For example, you might not like the idea of your annuity dying with you. Or you might believe that your sustainable income from drawdown would be higher.
Annuities are not right for everyone. However before ruling them out completely and forever, it’s worth being aware of some of the myths surrounding them. Let’s look at a few.
Myth 1: Annuities are investments
You pay in your money and you receive your income. It’s true, that feels like an investment. But annuities are actually insurance policies issued by insurance companies. You’re insuring against the risk that you might live longer than expected. That’s the exact opposite of life insurance, where the risk is that you’ll live shorter than expected.
With life insurance you typically pay monthly premiums, and your estate gets a lump sum if you die before a certain age. But with an annuity you pay a lump sum premium, and you get back a regular income for as long as you live.
Thinking about an annuity as an insurance policy can be helpful in deciding whether you need one, and if so how much you need.
Myth 2: It has to be all or nothing
Perhaps you assume that your pension plan must either be in drawdown or else fully converted into an annuity. So you might believe you’d have nothing to leave as a legacy from your pension if you bought an annuity.
In fact there’s nothing to stop you converting only part of your pension plan into an annuity, leaving the rest in drawdown. So for example, you could buy an annuity that just covers your basic expenses.
If you wanted you could buy an annuity with money outside your pension plan. This is known as a purchased life annuity, as opposed to a pension annuity. With a purchased life annuity you don’t touch your pension fund, which can be good for inheritance tax planning. And you typically pay much lower income tax, as the principal is deemed to have already had tax deducted.
Myth 3: Annuities die with you
If you’re a couple, maybe you’re concerned that if you die early, any annuities you have will stop paying income. So your partner wouldn’t have enough to live on. In fact you can buy a joint life annuity. Your partner can then continue to receive all or a portion of your annuity income. The trade-off is that the income for a joint life annuity will be lower than for a single life annuity.
If you’re concerned about not leaving enough to your other dependants, there’s the option of buying an annuity with a guarantee period. This continues to pay out for a few years after you’ve died (or both died in the case of joint life). Again the trade-off is that the income will be lower.
Myth 4: The provider might fail
This used to be a real concern. If you have an annuity with an insurance company that goes bust, then it won’t be able to pay your income. However the Financial Services Compensation Scheme (FSCS) now protects consumers against failures of eligible providers of annuities.
Myth 5: Annuities are risk-free
The other myths we’ve talked about might have put you off annuities. But this last myth might make you too excited about certain types. It’s true that annuity income is guaranteed. But there’s still a risk as to whether that income will keep pace with your cost of living.
The simplest kind of annuity, and the one with the most attractive headline rate, is a level annuity. This means that it will pay out a fixed sum, now and forever. The longer you live, the less buying power that income will have. So this type of annuity doesn’t protect you against inflation. One way of mitigating against this is to stagger annuity purchase, buying a mini-annuity each year. This can have the added benefit of getting ever-higher annuity rates as you get older.
To eliminate inflation risk entirely, you could buy an index-linked annuity. The income would be guaranteed to keep pace with inflation, but it would start much lower.
There’s also the option of an annuity where the income rises by a fixed amount each year. This may be worth considering, but it doesn’t eliminate inflation risk, if inflation rises faster than the income.
There are just too many possibilities
Yes there are. You’ll certainly need regulated financial advice before you buy annuities. But there’s a way you can get a quick idea of what, if any, type of annuity might suit you, how much guaranteed income you could aim for, and when you might start considering buying an annuity. When you use EvolveMyRetirement® to generate an optimised strategy, it does so with no agenda. It will only include buying annuities in your strategy if this results in better outcomes. And it has no bias as to what type of annuity might be suitable for you.
For some people their optimised strategy doesn’t include annuities. For others it may. And if it does but you still can’t stomach annuities, you can always tell EvolveMyRetirement® to rule them out. But the best approach is to take an objective look at your options.