The pension freedoms introduced in 2015 have provided more choice for people, but for many the guaranteed income that an annuity provides remains an important consideration, especially later in retirement. Although sales have fallen dramatically, there are still approximately 80,000 annuity products currently sold each year.
Annuity rates have been in a steady decline and the government’s quantitative easing programme and EU referendum result pushed rates down to historic lows. Although we are starting to see a mini revival, with gilt yields and therefore annuity rates starting to rise, it’s unlikely that this will be enough for a full resurgence in annuities. Instead, flexi-access drawdown is emerging as a popular retirement option.
The government is encouraging people to work for longer, and this ‘Fuller Working Lives’ framework sits well alongside flexi-access drawdown. It means people can phase their retirement over a number of years, draw some income and continue (along with their employer) to contribute to their pension fund, albeit with a restricted annual allowance.
Costs for drawdown have reduced too, so this is no longer only a suitable retirement option for the wealthy. And there has been a significant rise in non-advised drawdown since the freedoms, which reduces the overall short-term cost to the consumer.
New retirement income products
The decumulation options for those entering retirement are set to grow. The Financial Conduct Authority is considering how best to encourage innovation as part of its retirement outcomes review, and while so far we have only seen a handful of new innovative products, more are likely to be in the pipeline.
Better use of digital technology is also helping with consumer engagement, enabling someone to view their full wealth in one place and manage their drawdown income online. The flexibility that drawdown provides for people, combined with accessible and powerful self-service online tools, is a big draw.
Increasingly, most people will need to use up all of their pension assets to fund retirement. We don’t know when we will die, so judging what constitutes a sustainable level of drawdown income is problematic. Combine that with the associated investment risks and it becomes an exercise in crystal ball gazing.
And it’s human nature that as people get older they are likely to disengage, preferring a guaranteed income to provide security for the remainder of their retirement, without the need to check every day to see how their drawdown investments are performing. The prevailing annuity rate may not even be the most important factor here for this group.
So, we could be looking at situations where an individual enters drawdown and takes say 4 per cent income for a few years, possibly while they are phasing in their retirement, and then converts to an annuity further down the line.
Following the pension freedoms, we didn’t see the type of reckless behaviour which some predicted, although HM Revenue & Customs collected £1.5 billion from pension withdrawals in 2015/16, five times more tax than it anticipated. The average initial withdrawal currently stands at around £14,000 – not enough for a new Lamborghini.
Many have opted for their tax-free cash and left the balance invested, hoping to benefit from investment growth. We won’t really be able to assess the ramifications for another 10 to 15 years, by which time any drawbacks should be manifest. However, greater digital engagement and sound financial advice should go a long way to mitigate any downsides.
Annuities still have their place
If you look back to the glory days of annuities, a healthy man in 1990 investing £100,000 would receive an annual income of £15,000. By August 2016, 15-year gilt yields were just 0.9 per cent. Annuity rates are currently hovering around the 4.5 per cent mark, so if that healthy man from 1990 were investing £100,000 into an annuity now, he would receive back around £4,500 per year.
It’s unlikely that annuities will return to their position as the principal retirement option, but they will continue to play a significant part in retirement planning.
The way we fund our retirement is already starting to change, and the industry is responding with innovative products to help meet our new circumstances. We can help ourselves, though, by having a large enough retirement pot to meet our needs. We need to get the message across that it is never too early to save for retirement.
Adrian Boulding is director of retirement at Tisa
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