Analysts at RBC Capital Markets recently released a note anticipating five per cent growth in the annuity market. After falling 90 per cent by volume and 70 per cent in value since former Chancellor George Osborne announced the pension freedoms, RBC believes that the annuity market has now bottomed out, and open market insurers are set to cash in on growth.
RBC is forecasting 5 per cent annual increases in annuity market sales as a greater number of people retire with defined contribution pots and look to annuities.
Pensions freedom has certainly dealt a big blow to the market, but there are many reasons why it is still considered prudent to secure a guaranteed level of income during retirement.
Balancing retirement variables
Variables include investment returns, as well as inflation and most importantly the life expectancy of the retirees and their dependants. With an annuity these risk factors are taken on by the insurance company, something they do by pooling many investors and averaging the risk.
Just looking at longevity shows the difficulty in forward planning. Life expectancy at birth has risen by 8 years since 1982 and the trend is upwards. Overspending early in retirement could potentially mean running out of money or adversely having too much left at death that could be subject to inheritance tax charges.
Therefore, it is still sensible for most at some stage during retirement to transfer some of the risk, at least partially, to an insurance company via an annuity purchase. With the annuity market struggling over the past few years (in the three months immediately after the freedoms launched in April 2015, just 12,418 annuities were sold – in the same period in 2013 that figure was 89,896) and more people entering retirement in good health, an annuity is unlikely to be the chosen option for most in the early stages of retirement. However, as age increases, potential ill health and more certainty become important, then there will be a time for consideration of an annuity.
Recent changes to death benefits
Changes have been introduced to make annuities more attractive than before in terms of death benefits. In effect, they have the same tax benefits of flexi-access drawdown whereby the death benefits are tax free should the death occur before age 75 and conversely subject to tax if death occurs post 75.
An annuity purchased on a joint life basis will allow the annuitant a guaranteed income for life. Should the annuitant die at age 73 then the surviving spouse will receive the entitled benefit paid tax free, regardless of other income. However, should the annuitant die after age 75 then the surviving spouse will receive their benefit and it will be taxed as income.
Placing a guaranteed period on the annuity also works in the same way. So, for example, should an annuity have a 15 year guarantee and death occurred after 5 years then the income will continue to be paid for the remaining 10 years and is paid tax free.
Value protection is also available on annuity purchases. Although probably the least common death benefit considered, it is effectively a money back guarantee. Again, the death benefit rules apply and age at death is the key point. If an annuity is purchased with 100% value protection then the purchase price (minus fees and income taken) will pay out the remaining balance tax free should the annuitant die before age 75. If death was to occur post 75 then this would be taxed at the recipient’s higher marginal rate.
There are a variety of options available when taking out an annuity. Conventional annuities have no investment element – it provides a known income throughout your lifetime, possibly longer, if you include some of the additional options available. Alternatively, there are annuities with an investment element, which offer the potential for an income which increases, if investment returns are good.
The additional options that can be added to an annuity are as follows:
- Fixed income or escalating per annum payments
- Single Life or Joint Life
- Guarantee periods
- Value protection
- Payment frequency
- Payable in advance or arrears
Careful consideration should be given to all areas when deciding on an annuity purchase. You need to know which type of product and which, if any, additional options are the right ones to meet your needs.
Circumstances and objectives will alter over time and by receiving financial advice from a professional who can make sense of the many changes and their impacts is vital in retirement planning.
Annuities are there to make sure you’re not facing your golden age with very little left in income, which appeals to many clients, regardless of their circumstances.