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Annuities: What’s so bad about a guaranteed income for life?

Photo of Mark Meldon, IFA

This guest post is by Mark Meldon, an independent financial advisor (and Monevator reader!) who we’ve noticed talking a lot of sense over the years.

With more and more Baby Boomers reaching retirement, I thought I’d mount a defence of the much-maligned annuity as a solution to the question of after-work income.

As an IFA, I have seen a big increase in the number of enquiries from individuals wanting annuities rather than ‘flexi-access drawdown’ this year, and I think I know why.

But first, a little bit of history.

A serious business

…but if you observe, people always live forever when there is an annuity to be paid to them; and she is very stout and healthy, and hardly forty. An annuity is a very serious business; it comes over and over every year, and there is no getting rid of it.

– Jane Austen, Sense and Sensibility (1811)

What Jane Austen said over 200 years ago is still quite true today. Those who purchase a guaranteed income for life via an annuity – whether through using their pension fund to do so or, much more rarely, by spending their own money – tend to enjoy better-than-average health and suspect that they will live for a long time.

Otherwise why would they do it?

They also appreciate something often misunderstood by most of the population – you will live longer than you think, unless you are very unlucky.

Nowadays, even those suffering poor health or making poor lifestyle choices – smoking is an obvious example– can get recognition for their reduced life expectancy with underwritten annuities.

Annuities have been around in one way or another since Roman times and were very popular following the founding of Equitable Life in 1762 and the establishment of hundreds of competitors in the centuries that followed. Even the government sold annuities up until 1928.

Back in the 1970s and 1980s, there were well over a hundred life offices arranging annuities1. Now just a handful remain – we will see why that is a little later!

So, what, exactly, is an annuity?

Upside down life insurance

One way to think about annuities is that they are the reverse of a life assurance policy.

If you buy a life assurance policy you make small regular payments to your life office and, should you unfortunately die during the term, they send you a big cheque.

The reverse is true with an annuity. Here you send the life office a big cheque and they send you little bits of money until the day you die.

Most annuities are fixed in payment, but those that increase by a fixed percentage (‘escalation’) or by reference to the RPI (Retail Prices Index – a measure of inflation) are available and are a sensible choice if you can afford one.

We can see, therefore, that an annuity insures the annuitant against longevity risk, because of the guaranteed lifetime income stream.

You simply don’t get that with any other kind of investment – period.

I have arranged hundreds of annuities over the years, nearly all of them pension-funded ones. I can honestly say that nobody, ever, has been unhappy with the annuity. These individuals were not fazed by the ‘annuity puzzle’.

The annuity puzzle

In recent years, lots of economists have spent a great deal of time wrestling with what they like to call ‘the annuity puzzle’.

This so-called puzzle was first drawn attention to by Franco Modigliani in his Nobel Prize acceptance speech in 1985.

Modigliani said:

“It is a well- known fact that annuity contracts, other than in the form of group insurance through pension systems, are extremely rare. Why this should be so is a subject of considerable current interest. It is still ill-understood.”

What Modigliani said a third of a century ago remains true today.

According to Shlomo Benartzi, Alessandro Previtero, and Richard H. Thaler2:

‘Rational choice theory predicts that households will find annuities attractive at the onset of retirement because they address the risk of outliving one’s income, but in fact, relatively few of those facing retirement choose to annuitize a substantial portion of their wealth.

Adding some behavioural factors only deepens the puzzle because annuities have the potential to solve some complex problems with which individual struggle, like when to retire and how much they can spend each year in retirement, and thus they might be expected to be attractive for that reason as well.’

Benartzi, Previtero, and Thaler go on to say something very important and relevant to today’s ‘at retirement’ sector:

‘In addition to these arguments based on rational choice theory, certain behavioural factors should, in principle, increase the attractiveness of annuities.

As a first approximation, middle-class American households spend what they make. Whatever saving takes place occurs via pensions and paying off home equity, and the latter vehicle seems to have become much less fashionable in the last decade.

If the primary income earner in a household retires, the ‘spend what you make’ rule of thumb is no longer available. Instead, households who choose not to annuitize must learn a new skill, namely calculating the optimal drawdown rate over time.

Given the complexity of this optimization problem, it is not surprising that retirees might err, either by under-or overspending. These errors can easily be exacerbated by self-control problems if households have trouble sticking to their drawdown plans, either by spending too little or too much.

By converting wealth into an annuity, individuals and households can simultaneously answer the conceptually difficult question of figuring out how much consumption is sustainable given the age and wealth of the consumer and provide a monthly income target to help implement the plan.’

I like that – a lot! This is, after all, exactly how ‘defined benefit’ (aka ‘final salary’) pensions and our state pension works – a guaranteed income for life, with some inflation proofing, too.

They can give a ‘baseline income’ covering regular bills, and other pension funds and investments can cover other expenses as they arise.

So why are annuities still so unpopular?

Annuities are not at all sexy. They are also very much a one hit wonder as far as IFA and financial services companies fee-earning ability is concerned.

Nor can they help the reckless squander their capital!

Not so long ago I was at a conference concerned with the ‘at retirement’ market. The speakers produced various tax-planning tips, observations on the state of the investment markets and several technical sales techniques, and how much money they were making ‘managing the Baby Boomers money’. Whilst all this was very impressive in its way, and undoubtedly some of the ideas promulgated might work in certain circumstances, I did find the whole day rather discomforting.

When asked, I said how ridiculous it was that the retired had to spend so much time thinking about their investments, taking and paying for advice, and worrying about the stockmarket. I said I thought that for many it would be much better to cover their financial backsides with a lifetime annuity.

A couple of the presenters seemed to question my views and suggested some naivety on my part.

As I trudged across the rain-swept car park I wondered who was right.

Was it them with their discretionary fund management offerings, index funds managed by algorithms (what?), venture capital trusts and offshore investment bonds? Sure, these things can be useful in certain situations, but they all involve risk, sometimes very substantial risk.

Perhaps my line of thinking about how best to secure my clients a decent amount of worry-free lifetime income with at least some of their wealth is rather old-fashioned, but I remain convinced that it has its place for many people.

A 19th Century digression

I need to mention here another long-dead novelist, Anthony Trollope, who was writing his Palliser series of novels about 50 years after Jane Austen wrote Sense and Sensibility.

Since the turn of the year, I have been re-reading these great stories at bedtime – I’m about to start Phineas Redux – and something struck me related to my work.

Trollope’s middle and upper-class characters are always banging on about how much money they have, but, in contrast to the IFAs I met at that Exeter conference, their 19th century fortunes are almost always described in terms of the annual income they produce, not the lump sum.

It seems to me that hardly anybody talks about investments that way now. It’s all about net worth and asset value. I do wonder if asset values have come to play such a big role in modern financial life that we’ve forgotten what those assets are for?

In Trollope’s world, people bought shares purely for the dividend. Now dividends are usually an afterthought, with price appreciation the main goal.

I think that is wrong-headed.

Annuities don’t buy Aston Martin’s

I took a call in my office the other day from a lady seeking help with a pension sharing order following her divorce.

She didn’t appreciate that she won’t be getting a pension when it goes through. She will get an investment account wrapped up in a pension, unlike her ex-husband, who will continue to receive half his indexed-linked final salary pension. This lady was very shocked to learn that she must think about investment, interest rates, longevity statistics and all that kind of thing when her ex doesn’t.

I suspect that she might well choose to annuitise part of her eventual fund in a year or two, as she did understand the guaranteed income for life bit of our discussion.

Yet this lady also helped confirm what I thought was merely an urban myth. A close relative of hers took a transfer out of his employer’s final salary pension scheme just past age 55. He then cashed-in the whole lot – paying away almost half the fund in tax and losing his personal allowance – and blew £160,000 on an Aston Martin DB11.

I said that was completely crazy and she agreed. Apparently, the gentleman enjoys good health, but he sure is going to be income poor when he is 80.

I have no reason to disbelieve this story.

So, what to do when it comes to annuities?

I recommend you think hard about all options when you are nearing retirement and looking at your investment choices:

  • Consider annuities very seriously.
  • Maybe mix and match annuities with other financial arrangements.
  • Conventional annuities are certain! Nothing else is. There are investment linked annuities around, but these are not ‘certain’ in the same way.
  • Annuities don’t cost much to arrange. An IFA will charge to search out the best deal and to set one up – but there are no ongoing fees to pay, as far as the annuity purchase itself is concerned.
  • Most annuities involve no investment risk.
  • If you think you will live forever, an annuity is a great idea.
  • If you think you will die soon, think hard about not buying an annuity.
  • Final salary pensions are, in practice, annuities.
  • So is the state pension.
  • You can use ‘flexi-access drawdown’ as the icing on the cake – but remember it isn’t guaranteed and it costs a lot to run.
  • You say you don’t want an annuity? But do you really want to be invested when you 90 – or a landlord with a portfolio of buy-to-lets?
  • Remember inflation. Even today, with inflation quite low in historical terms, rising prices quickly erode the purchasing power of a fixed income. You can purchase annuities that increase in payment by a fixed percentage – usually with a maximum of 8.5% per annum – or index-linked annuities that are referenced to any increase in the RPI. In many ways, an index-linked annuity would be ideal, but they are very expensive, often reducing the ‘starting’ income compared with a fixed annuity by around 50%.
  • If you are worried about dying sooner than average – and thus subsidising those who live longer than average – consider a life assurance policy for your financial dependants
  • Don’t arrange a single-life annuity if there is someone else financially dependent on you
  • Finally, annuities offer something priceless – peace of mind!

Mark Meldon is an Independent Financial Advisor based in Cheddar, Somerset. If you need an IFA closer to home, try the directory at Unbiased. You can also read Mark’s other articles on Monevator.

  1. Source: UK annuity price series, 1957-2002, Edmund Cannon & Ian Tonks, University of Bristol & University of Exeter []
  2. Annuitization Puzzles – Journal of Economic Perspectives – Volume 25, Number 4, Fall 2011 []
{ 121 comments… add one }
  • 1 Neverland May 1, 2018, 9:53 am

    Annuities are great, especially indexed linked and offering a spouse’s pension

    Its the rates on offer for the cash parted with which are the problem

    Very few people have big enough defined contribution pensions to be able to live off what life companies offer

    To those that do, who have largely avoided the finance industry to invest successfully themselves, the bargain looks a poor one compared to a DIY solution in retirement

    For sure there is a big mess coming in the 2030s when people in their 70s discover they have nothing left to live on but the state pension

    But pensioners have traditionally been poor, there were never that many people in final salary schemes up until the late 1980s

  • 2 Accidental FIRE May 1, 2018, 10:27 am

    I will have a pension starting at age 62 that will be relatively handsome. And I’m already financially independent, so I will be using the ‘mix and match’ strategy once I start collecting it. Pensions are increasingly rare in America these days and I’m blessed to have it!

    Great rundown of annuities and I loved the historical context!

  • 3 Oscar Cunningham May 1, 2018, 11:24 am

    I just had a look at some annuity quotes and, if you demand RPI matching and retire at 65, they tend to offer around 3% of the lump-sum as an annual income. That seems pretty good; it’s not far from what people consider to be a safe withdrawal rate.

  • 4 Snowman May 1, 2018, 11:36 am

    Love the historical/literary references also.

    Given the mention of Trollope and annuities, it reminded me that Trollope put in his autobiography about giving up his income for life, by forgoing his final salary Post Office pension to live off his literary earnings.

    ‘The rule of the service in regards to pensions is very just. A man shall serve until he is sixty before he is entitled to a pension, unless his health fails him. At that age he is entitled to one-sixtieth for every year he has served up to 40 years. If his health do fail him so that he is unfit for further work before the age named, then he may go with a pension amounting to a one-sixtieth for every year he has served. I could not say that my health had failed me, and therefore I went without any pension”

    I think that meant he got no Post Office pension at all. Preservation of benefits was some 100 or so years away!!

  • 5 Adrian May 1, 2018, 11:38 am

    was doing well until he mentioned Equitable Life

  • 6 YoungFIGuy May 1, 2018, 11:39 am

    An excellent article Mark (as ever). I’ll confess I’m a bit gutted as I had planned out my own piece on exactly the same subject – so back to the drawing board!

    I 100pc agree with what you’ve written. If you’d indulge me I’ll share three thoughts.

    Firstly, I think the most important reason annuities get a bad rap is because they are seen as an investment/pension product and not an insurance product. As you rightly point out, whilst annuities are of course the former, they are, in practice, an inverse life assurance policy. Being somewhat flippant, nobody buys an insurance product because its a great investment product. They buy it for the peace of mind – perhaps more valuable than anything else!

    Secondly, I’m completely speculating here, I think some of the Annuity Puzzle can be explained by a combination of the Dunning-Kruger effect and individuals wanting to be in control. But there’s perhaps nothing worse than being in control of something you don’t know how to deal with!

    Thirdly, there’s a strong element of “throwing the baby out with bath water” in the mainstream media – “annuities are bad end of”. As you say, you can mix and match annuities with other financial arrangements. It’s not a case of annuity or not. You can annuitise part of your pension portfolio, or take a fixed term or flexible annuity (of course, that flexibility comes at a price). Boiling it down to a simple Good vs Bad is easy copy for the mainstream media, but the reality for individuals is more nuanced.

    Thanks Mark!

  • 7 Witzkrieg May 1, 2018, 12:04 pm

    I really enjoyed this article.
    It does mention one really important thing and that is that for most people, you shouldn’t have to worry about money – if you can afford to.
    Annuities mean you can get on enjoying life.
    I would not want to be 70 years old and still checking share prices daily and in the event of a Deepwater Horizon event – it could mean that someone who puts all their money in a single share or class or region… ends up in the poor house.

    Piece of mind must be worth something.

    My personal approach is to have a proportion of money invested in power generation. Like UKW. They pay out a reliable dividend and it should keep paying until I pick up my old company pension at 60 (another 25 years to go).

  • 8 Mark Meldon May 1, 2018, 12:16 pm

    @ YoungFIGuy

    Thank you, you are very kind. You are right in that annuities are ‘longevity insurance’. In my experience, all bar the unlucky live longer than they think. I have a relative who told me ‘I won’t see next Christmas’ – that was 26 years ago!

    I get the control thing, but, again in my experience, many people are not possessed of great self-control (me, too, sometimes!) particularly with money matters. We are a heavily indebted nation of borrowers and financial asset prices have undeniably been bloated by QE – I have worries about what will happen to all those ‘Pension Freedom’ users if and when we see a big correction. We have been there before.

    I’m also very fortunate in that many of my clients are in the great position of having been able to cover their monthly ‘bottom line’ by purchasing an RPI-linked annuity to do so. Such annuities seem to make up a tiny percentage of the annuity market, because people don’t seem to be able to get their heads around ‘nominal’ and ‘real’ returns. Sure, there is a ‘jam today’ trade off for those choosing a fixed annuity and slowly getting poorer as the years roll by because of the effects of inflation. Many clients have a wide range on income sources in retirement but only conventional annuities are certain.

    Here is a true story (OK it is a fixed annuity, but never mind!).

    In March 1991, a client of ours used her pension fund to buy an annuity with one of the Scottish life offices. The purchase price was £772,530, a very considerable amount 27 years ago. She was 60 at the time. The gross annuity offered was £73,332 per annum, so she got about 9½% on the pension fund, for life. Those were the days!

    You guessed it, here she is aged 87, still enjoying her £6,111 gross per month and having received a total income, so far, of £1,979,964. No wonder the life office demutualised a few years later.

    Oh, and she has another annuity, arranged in 1989, which is index-linked!

  • 9 Snowman May 1, 2018, 12:26 pm

    In the real world, it is surprising how few people actually think about what their minimum required base income is in retirement, and how much secure income they already have from state pension and final salary pensions.

    Once people think about this, then it becomes a simpler decision for them. Some might want to use an annuity to top up their secure income to around the base required level and then access the rest of any defined contribution pension flexibly. Others may convert the whole pot to an annuity, just to avoid the need to manage their investments. Either approach is fine as long as you understand your income position.

    I think neverland is right that there are large and increasing numbers (now that final salary pensions are dying off) who are reaching retirement and do not have a big enough pension pot to buy a big enough annuity to cover their needs. Some in this group would love to forget about investments by buying an annuity, but can’t afford to do so. So they don’t buy an annuity and cross their fingers that the money won’t run out.

    I think there is also a tendency for some people shunning annuities to under-estimate their life expectancy or to underestimate investment risk, especially the affect of market falls early in retirement. Many simply divide their pot by their annuity, come up with the multiple of say 30 and say something like “I would need to live to 90 to get my money back”. The same group often think that not buying an annuity means they will with certainty have more money to pass onto sons and daughters, as an “annuity stops on death”. In reality of course it depends on investment returns, investment costs, and how long someone lives etc.

  • 10 Survivor May 1, 2018, 1:25 pm

    Excellent article, I reckon there are several reasons annuities are under-appreciated & utilised. Pension talk bores people – until they need them & it scares many who do care so much that they bury their heads in the sand, [like hiding unopened bills in a drawer] & echoing the above comment, the gross savings needed these days to start off with are so high now, it looks like a bad deal to the layperson.

    Some people subconsciously probably also intend to ‘wing it’ by throwing themselves on the mercy of the state at the end so as to get a free ride. A lot of savvy investors are probably getting a better yield, with a balanced portfolio even, so see an annuity as a loss, though it’s a really good point that you can’t rely on ducking & diving when seriously old but still tinkering with your finances. So common sense would be to tailor your investment style as you age, to shifting more into annuity-like asset-classes so as to have a low-maintenance, steady, reliable income …..in much the same way you’d tailor easing from growth to draw-down through earlier life stages.

  • 11 YoungFiGuy May 1, 2018, 1:51 pm

    Wow that’s a great story Mark – what an amazing result for the client. I guess you don’t tend to hear the good stories in the media – I don’t think the headline: “Financial Plan works out well for yet another person” will sell many copies!

    The control thing is funny – Richard Thaler has a great story on self-control (and how he got in to behavioural economics); he was at a party where people just couldn’t stop gorging on peanuts before they sat down for dinner. They were literally begging for the nuts to be taken away before they ruined their meal (I know the feeling with the biscuit jar…) We’re all terrible at self-control, and it’s also really tiring. Taking that hassle off the table seems, in many cases, to be a sensible thing!

  • 12 Lindsey May 1, 2018, 1:52 pm

    May I convey heartfelt thanks to Monevator for hosting yet another excellent post, and to Mark Meldon, who so entertainingly lays bare his subject; also to regulars Snowman, Neverland and others. You’ll have guessed that this is a subject slowly rising to the forefront of my investment horizon, and having vastly enjoyed the learning curve of reaching FI, as for many others there’s now the basic dichotomy of surrendering control vs sleeping soundly.
    This certainly lends appeal to part-annuitisation, when clouds appear to be forming. I’m in the unusual position of having no direct heirs to whom I can pass my main residence, so my SIPPS form an integral part of my tax planning, and ISAs can defray other costs as necessary. However, ostensibly I could use some of that capital to buy a purchased-life annuity, and understand that they come in the same flavours – guaranteed for x years/index-linked etc, and wondered if anyone has any experience of such? I really love the idea that annuity-buyers are longer-lived, too!

  • 13 Little Miss Fire May 1, 2018, 1:53 pm

    I am very new to all things finance so I’d never heard of annuities before. I really liked how they are described here as well. I think I need to find out more about them. I had a pension with my work that pays me an annual amount once I reach 55 so I’m assuming thats the same thing? Sorry for the newbie question.

  • 14 Chris May 1, 2018, 2:18 pm

    One question: how can one be sure the life office, or whoever, goes on paying for the next, well it could be 35 years? Equitable Life didn’t… All those 100+ life offices have shrunk to a few, so been taken over etc: who back-stops the survivors? What is to stop some whizzo financial engineer taking over the annuity-payers and finding a legal loophole to reduce/stop payments, or moving them offshore, or whatever?

    Is there any kind of insurance for the insurance?

  • 15 Mark Meldon May 1, 2018, 2:20 pm

    There is something else that I should have pointed out, even though the subject is what the Victorians euphemistically called ‘natural decay’. In my experience, with honourable exceptions, age lessens our ability to deal with complex investment decisions (amongst other things) and this is an area where the predictability and reliability of annuity scores highly compared with flexi-access drawdown. Over the years, some clients have opted to use their pension fund to buy an annuity as they ‘just can’t be bothered anymore’ with riskier investments. That’s regardless of the IHT efficiency and ‘inheritability’ of the pension fund (which might, after all, be a ‘red herring’ for most people).

    I’m obliged to understand the Mental Capacity Act 2005 as part of my job; if you can’t understand things so well anymore I have to deem you a ‘vulnerable client’. That isn’t always age-related, alas, but it often is. Who will manage your drawdown pension if you lose the plot? You had better set up a lasting power of attorney https://www.gov.uk/power-of-attorney if you want to stay in FAD long-term. The Trustees of your pension fund can’t take instructions from you if you have ‘capacity issues’ and you financial adviser is in a bind, as will be your family.

    You don’t have that problem with annuities.

  • 16 Mark Meldon May 1, 2018, 2:31 pm

    @Chris.

    That isn’t a worry! Anecdotally, the last time an annuity ‘failed’ in the UK was when Henry VIII was our King – you see, some monasteries offered them and he abolished the lot!

    Annuity ‘books’ are often offloaded by one office. Standard Life, for example, will be selling its old life & pensions business to Phoenix Life soon and several recent purchases of annuity books have taken place. Here is another example https://www.ftadviser.com/2016/05/23/pensions/annuities/aegon-sells-bn-annuity-book-o26ToGNjUeZLabUtfwivzK/article.html. Rothesay Life (www.rothesaylife.com) are also active in this market.

    On top of this, annuities are 100% covered by the Financial Services Compensation Scheme (FSCS) https://www.fscs.org.uk/what-we-cover/products/pensions/fscs-compensation-for-pensions/

    In actual fact, no Equitable Life conventional annuities fail to be paid. The ‘scandal’ mainly concerned with-profit guarantees that were, ahem, ‘diluted’.

    Annuities are very safe!

  • 17 Mark Meldon May 1, 2018, 2:32 pm

    @ Little Miss Fire.

    It sounds like you have a ‘Defined Benefit’ or ‘Final Salary’ pension scheme – you are right in this is very like an annuity.

  • 18 Neverland May 1, 2018, 2:50 pm

    @Mark Meldon

    “In March 1991, a client of ours used her pension fund to buy an annuity with one of the Scottish life offices. The purchase price was £772,530, a very considerable amount 27 years ago. She was 60 at the time. The gross annuity offered was £73,332 per annum, so she got about 9½% on the pension fund, for life.”

    So basically you would need to pay about GBP 3.2m to get the same income unindexed today which would be about GBP 150,000 per annum adjusting for inflation, because I think the unindexed annuity rate for a single life at age 60 is a little under 5% currently?

    You’ve just illustrated very nicely why no one buys these products any more – no one can afford it

  • 19 Mark Meldon May 1, 2018, 3:13 pm

    @ Neverland.

    I have just run some quotes in ‘real-time’ courtesy of Canada Life (not necessarily the best rate, but representative). The quotes are all for a female 60 years old exactly in average health assuming an annuity paid monthly in arrears, with a proportionate payment on death and incorporating a 5-year guarantee.

    Purchase price £772,530 – gross level annuity £38,131.08 per annum.
    Purchase price £1,500, 000 – gross level annuity £72,673.68 per annum.
    Purchase price £1,500,000 – gross RPI-linked annuity £35,450.04 per annum.

    Bearing in mind that you might get 3.5%-4.5% ‘natural’ income from drawdown – with no guarantees, remember – that’s not too bad a set of quotes.

    If someone waved a magic wand and offered me £35,000 a year index-linked annuity income, I’d bit their hand off, I really would!

  • 20 Witzkrief May 1, 2018, 3:14 pm

    I think that one of the main problems of annuities is well illustrated by the fact that you could once get 9 1/2% for life on your £700k – and now, if you had £700k that’s grown to £3m with asset price inflation over the years and a 3% annuity gets you the same amount of retirement income.
    Now – here’s the rub! Those who didn’t have £700k 25 years ago are left in a position of trying to find retirement income which will be a lot less than £3m. So 3% of not much looks like a bad deal.
    So… they stick their heads in the sand and hope it’ll all be ok. Or work forever!

  • 21 hosimpson May 1, 2018, 3:26 pm

    I don’t know. If you own your house mortgage-free then in theory a large portion of your expense base is fixed already. You can either take out an inflation-adjusted annuity to cover your rent, or you can buy a house with no mortgage and a book on DIY, and have comparable outcomes. Do I need an annuity to cover the cost of utilities, food and clothing? No.
    I can see the benefit of taking out an annuity in my 70s – less hassle and it’ll be cheap(ish) at that stage – but I don’t see myself doing it in my 50s or 60s.
    Oh, and also: Equitable Life.

  • 22 Mike May 1, 2018, 3:33 pm

    For those of us who have left our DB schemes would buying an annuity not be akin to jumping out of the pan in to the fire and then back in to the pan again?

    I have wondered though whether in say 10 years time if interest rates have normalised whether leaving a DB scheme but then buying an index-linked annuity will actually look like a great option.

  • 23 The Investor May 1, 2018, 3:35 pm

    @all — When lamenting the fact that you weren’t retiring in 1991 and buying fixed rate annuities with a 9%+ rate, remember (a) that inflation in 1991 was far higher, somewhere around 6-7% from memory and (b) they didn’t have Netflix.

    Seriously, yes it offered a better real rate — and the collapse in inflation and interest rates over the next 25 years makes it look like bargain of the century in retrospect — but you didn’t know that was coming when you bought then.

    I can very well see why people are wary of annuities at today’s low rates, on balance I feel similarly cautious personally, but beware of hindsight bias.

  • 24 The Borderer May 1, 2018, 3:42 pm

    @Oscar. The 3% return from an index linked annuity is, as you say, not far (or even better than) a SWR using drawdown. But the principal is gone – using drawdown it’s still there (+/-).

    And another consideration. With drawdown you have a lump sum of money. Let’s say (God forbid) you or you’re spouse are diagnosed with a terminal condition. At least with drawdown you could take that round the world cruise, or private nursing or anything else – in other words, options. With an annuity, all you have is the security of a few thousand a year until the inevitable happens.

    IMHO an annuity might be a good option when you’re much older – but not for those who aim for RE.

  • 25 YoungFiGuy May 1, 2018, 3:44 pm

    Just to back up Mark and TI – remember that the annuity rate is a guaranteed % per annum; the stock market return isn’t! The price you pay for the certainty is a lower annuity rate compared to the market return. Also bare in mind that 10yr and 30yr gilt yields were c.12% in the early 90s and inflation over 8%! Mark’s client did “very well” with their annuity at 9.5%. It’s entirely possible to “do well” with an annuity at 4% where gilt yields are at 2% and inflation at 2.5%!

  • 26 Jane in London May 1, 2018, 3:51 pm

    A really interesting piece, Mark – thank you.

    I am now retired, with my current income provided by a high-end rental (non-mortgaged) property which gives me a decent whack each month after all expenses. I have a reasonable stash of investments and savings for use if necessary.

    Allowing for my enhanced state pension which should kick in when I’m 66, with luck and a good following wind I hope to be able to leave my SIPP pot untouched and growing for at least the medium term.

    But the idea of using annuities has always been in my mental toolbox should it prove necessary to generate a larger, guaranteed income as I age. Or if I find I simply can’t be arsed with managing investments any more! And yes, like it or not we become less mentally sharp with age.

    Tax-wise, I would presently be reluctant to buy an annuity before age 75 but that could change if this tax break (which looks a bit incongruous since the abolition of compulsory annuities after 75) is taken away.

    I think annuity providers could do a lot more to tailor and market their products to appeal to those who would most benefit from them. The literature is often pretty dire, and does little to dispel the popularly-held belief that they are a bit of a rip-off.

    Of course, the pensions industry did not help with that when it funnelled customers into ‘captive’ annuities at rubbish rates. And, as has already been pointed out, there is the spectre of Equitable Life…

    But you’d hope that someone with an eye to the future would want to do some scrupulous product innovation to catch the interest of all those cashed-up baby boomers!

    Jane

  • 27 Mike May 1, 2018, 3:54 pm

    Starting from where we are now in terms of IR’s would it be reasonable to start buying annuities in tranche’s to try and mitigate volatility and locking yourself in at a poor rate of return?

  • 28 Mark Meldon May 1, 2018, 3:55 pm

    I’ve just run those quotes again, but added 10 years of age to our hypothetical annuity purchaser.

    Purchase price £772,530 – gross level annuity of £48,687.48
    Purchase price £1,500,000 – gross level annuity of £92,162.28
    Purchase price £1,500,000 – gross RPI-linked annuity of £54,785.88

    So you wait 10 years you get more (because you will receive it for fewer years).

    BUT!

    You have irrevocably lost income of £381,310.80 in the first example, £726,736.80 in the second example and at least £354,500.50 in the final example – without adjusting for inflation.

    If average life expectancy is actually achieved, the lady aged 60 might expect to receive a gross total income of £2,107,536.72 by the time she dies, the lady aged 70 £1,804,844.65.

    Most of my clients have preferred the ‘bird in the hand’ approach and have annuitized sooner than they might have expected to. They enjoy puttering around on their boats or whatever at age 61, which might be rather harder at age 71!

    At 60, a woman might expect to live to age 89. At age 70, she might expect to live for another 19 years and seven months. (Source https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/lifeexpectancies/bulletins/nationallifetablesunitedkingdom/2014to2016)

    We can see, therefore, that the level, fixed, annuity bought at age 60 for £1.5m would pay a total of £

  • 29 Mark Meldon May 1, 2018, 3:55 pm

    Sorry, something went wrong with the formatting there!

  • 30 The Borderer May 1, 2018, 4:08 pm

    @Mark Meldon

    The income of eg £381,310.80 ‘irrevocably lost’ assumes that the eg £772,530, is left under the mattress for 10 years and not invested. Assuming 4% real return it could have grown to £423,000.

  • 31 Ms May 1, 2018, 4:15 pm

    Thanks Monevator for drawing attention to this subject and to everyone who has commented. It’s come at an ideal time for me as I have shortly to decide whether to use my AVC fund to 1. buy pension income via my company pension fund, 2. buy an annuity from another provider , 3. take the tax free cash, 4. use it to fund another arrangement such as drawdown, 5. A mix of the above. I was disappointed by the projected income from option 1. as projections in previous years were so much better. The discussion has helped to clarify my thoughts.

  • 32 Mark Meldon May 1, 2018, 4:22 pm

    @The Borderer

    Of course, you are right, but that isn’t guaranteed – it could be a lot more or it could be a lot less. If you just parked £1m in ultra-safe NS&I Income Bonds you get 1% gross interest.

    Also, what if something goes wrong with your investments, akin to the troublesome period in 2008? If your £772,530 fell by 50% it has to double and more to get back where it was and that’s a tall order.

    I have several clients in FAD and most don’t need or wish to buy an annuity for all sorts of reasons – they might have income from a mixture of secure and unsecured sources for example.

    I also have clients who chose to ‘mix and match’ using a combination of FAD and annuities, not all bought at the same time. It’s all very personal, these decisions!

    Sure there are times when an annuity or ‘final salary’ pension is the last thing you need – I have a client for whom I undertook a pension exercise just after his diagnosis of motor neurone disease – poor fellow – and annuity was not much use to him.
    All I’m saying is that annuities have a valuable role to play, that’s all!

  • 33 The Borderer May 1, 2018, 4:37 pm

    @Mark Meldon

    Yes, my own view is that they DO have a place in a retirement plan. As William J. Bernstein says, once you’ve won the game, put all your money into safe assets.

    Just saying, but if you do quote an example, then please compare apples and apples, this is a Monevator site after all :)-

  • 34 Gadgetmind May 1, 2018, 5:39 pm

    I can’t see an annuity having any place in my retirement plans. I have exactly zero DB pension and my wife is close to ditto (a few £100 pa) so we’re all DC. I’ve just retired at age 55 and she will probably follow me in six months’ time.

    What kind of a pittance of *index linked* annuity would my DC pot of around £1e6 buy for myself *and* 100% of same for spouse should I die first? Compare that to what I/we can get from drawdown (with total annual fees of around 0.3% as I’m totally DIY). Yes, the latter isn’t guaranteed, but an annuity would probably give us only 50% of the income and GOK what age I’d have to live to for my money to have slowly trickled back to me.

    People will start buying annuities again if/when they start representing decent value.

  • 35 Colin May 1, 2018, 6:21 pm

    I had little choice with my main pension as a Defined Benefit scheme with CPI escalation and spouse benefits made taking it as an annuity was the best option.

    However when planning my (slightly) early retirement I started with an aim to limit my routine expenditure to the calculated pension amount. We had been living well within that amount for time before I semi-retired

    My view was that the annuity gave me assurance for the essentials of life (including some discretionary spending) but other sources were available to top up that for treats but there was little risk if those were fully used up Life would still be tolerable for us both

  • 36 Atlantic May 1, 2018, 6:48 pm

    A very timely article from my point of view. I retired 2 years ago and at that time had completely dismissed the idea of an annuity. However I have changed tack relatively recently, after scaring myself by reading several articles on sequence risk, (un)sustainable withdrawal rates, the risk of inflation and living too long etc etc ! I now see the purchase of a smallish RPI linked annuity as a good way to top up the state pension so as to have a higher level of inflation proofed, guaranteed income. Remaining funds will be in an income draw down SIP, but there will be a safety net below me.

  • 37 diy investor (uk) May 1, 2018, 6:51 pm

    What’s that point about flexi-access drawdown costing a lot to run…I have mine with AJ Bell and costs next to nothing.

    I compared annuities when I decided to take benefits from my pension in 2012 and was surprised at what poor value hey offered. I very much doubt if the situation has changed that much over the past 6 years so I am not convinced by this article at all.

    I get an average return of 8% p.a. from my drawdown and withdraw around 4% each year so the ‘pot’ is still growing. The actual amount I take out is better than I could get from a flat rate annuity and far exceeds an escalating annuity. PLUS I retain the capital at the end of the day which I can pass on to children/grandchildren.

    It’s a no brainer for me.

  • 38 Matthew May 1, 2018, 7:09 pm

    Really interesting original post and subsequent discussion. Although I absolutely agree with some of the opinions expressing a ‘dislike’ for annuities. I have reluctantly come to the opinion, that they will absolutely form part of my retirement income. The rates are not brilliant, especially if you intend to retire earlier, my fingers are still crossed for 55, but as the post says they offer certainty and I really like and value that. For those without DB schemes 🙁 I wish, I think they are hard to ignore. As mentioned it doesn’t have to be an either / or, I like the idea of the mix and match approach, with annuities for the floor income and drawdown for the fun stuff, which will be important especially in the earlier years of retirement.

  • 39 Richard May 1, 2018, 7:10 pm

    I wonder if people also like the idea of passing their wealth on to children / charity etc. Annuities die with you / spouse. Compound that with under estimating life expectancy and I can see certain groups who would want to keep hold of their wealth to pass on. Who cares when you are dead you ask? Well there was a lot of resistance to the dementia tax….

    The longer game though is potentially a return to the wealthy aristocracy of the past. Annuities destroyed a huge chunk of wealth, assuming the person who received the income spent it rather than saved / gave it to children etc (behaviour an annuity encourages over a large pot of money)

  • 40 Lady Aurora May 1, 2018, 7:15 pm

    Theres no point in having loads of money beyond 85 yrs of age. Your usually done with traveling and just want a more quiet life. So thats a X against annuities. You need your money early on 50, 60, 70s. TBH if your out of cash by 85yrs the welfare system will prob look after you after that.

  • 41 John B May 1, 2018, 7:23 pm

    Annuities have 3 aspects, lifespan risk reduction, investment risk reduction, fees for the provider. I can see the attraction in the first, worry how much the regulatory framework is pushing funds away from equity into bonds and sacrificing return, and wonder what %age of the lump sum gets taken in fees.

    So a few questions for Mark

    1) Can you get annuities at 50, or is it so much of an outlier no-one will quote, or quote very expensively

    2) Can you get an annuity-like product which pools funds for life expectancy, but invests in equity index trackers

    3) Do life companies have any obligation to quote their cost structure for annuities.

  • 42 ChrisB May 1, 2018, 8:05 pm

    So, at age 60:

    Option A: £1.5m index link annuity =£35k pa / no inheritance for my kids

    Option B: £1.5m in simple FTSE tracker = £40k pa / £1.5m inheritance for my kids

    No brainer.

  • 43 dearieme May 1, 2018, 9:19 pm

    Comparing a certain performance with an uncertain one is indeed reasonably described as a no brainer.

  • 44 Boltt May 1, 2018, 9:40 pm

    The difference / perceived poor value we are seeing from annuities is perhaps explained by how insurers price annuities.

    Generally they match assets and liabilities to manage capital requirements. Therefore, annuities sales are backed by gilts – and with 15+ year gilts yielding ~1.75% v the dividend yield of the FTSE 100 at ~3.5% we start to understand the discrepancy.

  • 45 Richard May 1, 2018, 9:57 pm

    @dearime

    Even option A is not certain if you consider the total return over remaining lifetime, as remaining lifetime is unknown. In either case you are playing with managing risk and how it aligns to your ultimate objective.

  • 46 FIRE v London May 1, 2018, 10:43 pm

    Excellent post – thanks Mark and @TI. Has a chance of being life-changing, which is as much praise as I can offer!

    The compos mentis argument worries me considerably. I spend far too much ‘hobby’ time considering investments. While my investment performance is reassuring, I am exposed to either a) becoming bored in 10+ years time’ – then what additional risks am I exposed to? or b) losing ‘capacity’. The annuity offers an appealing solution to this – one I appreciate more fully after this excellent blog post.

    I think for me the foremost use of an annuity is for Mrs FvL. She is not remotely as interested as me in investing/finances. While she has a reasonable understanding/capacity for it, given her lack of interest I don’t want her to take on, if I’m not around/able, what she will see as a burden/chore. And she is definitely the Spender not the Saver. For both reasons I think having a nice clear monthly number, perhaps increasing annually, offers real attractions.

  • 47 Lad's Dad May 1, 2018, 11:09 pm

    I think this particular cohort, with a wealth of experience of managing their own portfolios, will always be sceptical on the value of annuities.

    For Average Joe with minimal interest in Financial Services, an annuity teamed with State Pension should prevent most folk from losing their independence in retirement.

    On balance, it’s easy to be blasé on annuities off the back of a 10 year bull run, whilst atill earning a decent wage, with a decent retirement stash awaiting retirement

  • 48 Hariseldon May 1, 2018, 11:53 pm

    The underlying investment in annuities are gilts.

    The returns available on a gilt portfolio to provide an income over a 30 or 40 year period are at a low level and for inflation linked gilts are heavily negative…

    In addition you are effectively buying an insurance policy to cover longevity risk and are forfeiting an income ( less any guaranteed payments) if you die early.

    The product is not transparent and you have no idea of the costs of the product…remind you of endowments….

    Had I taken a flat annuity at 49 , 11 years ago I had would have had a fair income and no capital.

    I have received a similar income from my investment portfolio and I have still have my capital, plus an additional seven figure sum.

    Should I wish to put the lot in gilts now i could secure the same income as the original annuity in 2007 but would need to draw on some capital each year, my trusty HP Calculator reckons it would last 107 years until the pot is exhausted.

    You pay a very heavy price for reassurance….. annuities may suit some people but they are not the answer for everyone.

  • 49 weenie May 2, 2018, 12:20 am

    An excellent post, thank Mark. I think I’m likely to consider annuities when I feel that I can’t be bothered to tinker around with spreadsheets any more. I will have a DB pension and the state pension for my ‘bottom line’ and I was going to flexi-drawdown my two SIPPs for top up. Now, my thinking is that perhaps I might keep one untouched to buy a small annuity but probably not til when I’m in say my 70s. This post and many of the useful comments have certainly given me something to consider for the future.

  • 50 John B May 2, 2018, 8:13 am

    @Hariseldon, you need to be careful picking 2007 as an annuity start point, as we’ve had post crash rebound and a QE bull market since. Annuities have to bear the risk of the market/bonds falling after they are taken out, though of course you take on the timing risk of buying one at a particular point in the cycle.

  • 51 The Rhino May 2, 2018, 9:00 am

    Superb article. I very much like the idea of an annuity as a part of the overall retirement strategy

    The comments are also illuminating. Theres a good few exhibiting a lot of hindsight bias and comparing apples and oranges here. I think that makes the case for annuities more, not less pertinent?

  • 52 oldie May 2, 2018, 9:26 am

    Excellent and readable article. Shows for me the potential value of different and independent asset/income streams across the portfolio.

    Although wrong to let investment decisions be driven by taxation , is there an issue of any income being taxable directly, whereas there any capital could be managed to a degree by realising any gains/losses on an annual basis and using the capital allowance?

  • 53 John B May 2, 2018, 10:25 am

    @oldie One of the problems with pensions is that capital gain on investments becomes income on withdrawal. You can argue that unsheltered investments can keep deflating their capital gains tax burden at £11700 p/a, or just paying the tax at 10%, while from a pension you pay tax at 20%

    For 300k of equity unsheltered, earning 3.5% dividends and 4% capital gain before inflation, you can offset all 22500 of returns against income and CGT taxes, provided you have no other income.

    For 300k in a pension, you can get 5625 tax free, but pay 2130 tax on the 10650 over your income tax allowance. (But this applies whether you draw down your pension or buy an annuity, but you’d lose the 0% Inheritance Tax advantage with the latter.

    400k is the point at which dividends can’t be covered by allowances, and you’ll be paying £500 CGT a year

    Of course ISAs avoid it all, but the takeaway point is that might be a mistake feeling you need to get all unsheltered funds into pensions.

  • 54 Mark Meldon May 2, 2018, 11:03 am

    I have found it very interesting to see the various comments; there seem to be a few threads appearing and some might be looking through the ‘wrong end of the telescope’ in my view.

    For example, I think that the 2015 pension reforms have, perhaps, distorted the view of what pension funds are because of the ‘inheritability’ of the funds. This is undeniably very attractive and has been a key driver of many client choices over the last three years. But, a pension fund is there to provide you with a pension, period! If you are in the fortunate position of having a private pension fund that you don’t currently need you will recall that this has been built up with tax-relieved contributions and has been invested in a virtually tax-exempt environment. I’m not sure that it was George Osborne’s intention to create a ‘wealth transfer mechanism’ by allowing benefits to pass to the next generation (often tax-free) as the sole reason for the so-called ‘Freedoms’. Sure, if you are wealthy enough to take advantage of this then you should, but most people are not in that position.

    Oddly, the sales of guaranteed whole of life insurance policies hasn’t increased since 2015 (these provide a certain tax-free lump-sum on death if the plan is written in trust); there is an argument that those who really ‘want to pass my money on to the children’ and ‘don’t need my pension fund’ should be flocking to buy these secure life insurances. Then they can draw out their Pension Commencement Lump Sums and hand it over to the kids tax-free today – so they can hear them say ‘thanks’ whilst they are still alive – and drawdown an income they ‘don’t need’ and pass that on too. Sure, you have to pay premiums for a whole life policy, and these things can be (very) expensive, but they work.

    Is the truth of the matter that, quite rightly, people do think that they will need their ‘unwanted’ pension fund eventually? And they don’t really mean to make their 50-60-year old ‘children’ millionaires when they die? I’m not sure that many people have really thought this through, but that’s just my opinion this morning!

    The other main thread is that flexi-access drawdown is clearly superior to an annuity. That’s an unfair comparison. True, it might be ‘safe’ to rely on an income yield of, say, 3.5% from your underlying investments but that isn’t a certainty. If you have a £500,000 SIPP fund yielding 3.5% then you might expect (I’m ignoring tax here) an income of about £17,500 per annum. That’s great, but what if your investments fall in value by, say, 25%? You then have £375,000 and that will yield about £13,125. Sure, markets might recover, but you don’t know that. With an annuity (or ‘final salary’ scheme), for better or worse, ‘what you see is what you get’.

    Many of my clients chose a combination of retirement income streams, mixing guaranteed annuities as their secure income and their SIPP as their unsecure income. I think that can be very comforting.

    What I do, just as an aside, and this is (or should be) commonplace IFA advice, is to ‘park’ 2-3 year’s worth of my client’s income requirements from their FAD pension just in the SIPP bank account to create a kind on ‘income reservoir’; you can cope with bumpy markets if you have this ‘breathing space’. Dividend continue to accrue to the bank account, thus extending the period of relatively ‘safe’ withdrawals. This does work well in practice, I find.

    A few years ago, I had dealings with a chap who had a ‘SIPP’ with a large life office. It wasn’t really a SIPP as it was wholly invested in the life offices funds. He started off using the original drawdown facilities (they have been around for 20+ years), with a fully invested fund of £650,000 or so. He took his 25% tax-free cash of £162,500 at the outset and, basically, wasted that on living the high life instead of eliminating his interest-only mortgage – the money was long gone. He was drawing out, if I remember rightly, just under 5% per annum from his fund (so about £24,375 per annum, gross, on a fund of about £487,500 at outset) all of which was invested. He was a DIY investor and had never used an IFA, ever. He never changed the underlying investment choices, never read the annual review documentation, never reviewed his withdrawals, had no ‘cash reservoir’, never did anything. He set up his drawdown in, I recall, 1998. When he came to see me in 2009 his fund stood at £140,000 – he just could not understand why (at all!) it had gone down so much and his physical health had significantly deteriorated. He and his wife were suffering from severe ‘SIPP anxiety’ and didn’t know what to do.

    Remarkably, we were able to source a medically underwritten guaranteed annuity for them offering a rate of about 7.22%, so that gave him and his long-suffering wife a secure income (to which the wife was particularly attracted) of around £10,100 per annum gross. Thankfully his state pension had just started, so he ended up with about £20,000 a year secure income (IIRR). ‘That’s nowhere near enough’ he cried (even though we gently pointed out that he had all the ‘stuff’ he could ever need – he didn’t take that well) and shuffled off into the distance.

    A few months later, we were made aware that he had arranged a substantial equity release plan. I’m not a big fan of equity release and choose not to offer advice in this area (I know someone who does, and very well), but it has a role. We subsequently had a conversation with the chap who admitted that this was arranged just to pay off his outstanding interest only mortgage and would also give him about £250 extra a month to spend.

    We had no further contact with the chap, but I did discover that about three years later the lovely house he and his wife once owned in the West Country had been sold and a mutual acquaintance told us that he ended up in a small flat on the Dorset coast.

    Lot’s of ‘ if I hadn’t done that and done this instead’ there! So, be careful with your drawdown plan, especially after a good run in the markets!

  • 55 John B May 2, 2018, 11:38 am

    @Mark generally when equity falls, dividends fall less, and of course bond value falls do not affect their income. So yields rise in depressed markets.

    You said earlier “for a 60 y/o woman an annuity purchase price £1,500,000 – gross RPI-linked annuity £35,450.04 per annum”, so they’d need £750k to purchase an annuity to match the £500k SIPP in drawdown. A 50% bigger pot is pretty resilient to market fluctuations. You’d have to ask whether peace of mind is worth the extra cost.

    For your anecdote, the 11 years you quote had 2 market crashes, I guess he’d have to be drawing £25k fixed each year, not 5% variable, but I still marvel at the capital loss, as £15k of it should have come from conservative 3% dividend rate. His £140k would probably have made more than 7% annually from 2009 in our bull market. http://www.swanlowpark.co.uk/ftseannual.jsp shows 6 years with double digit growth, 2009 had 30% alone.

    Timing is all in markets, so I’m wary of anecdotes, as the one thing annuities can’t do is remove timing risk on their purchase.

  • 56 The Rhino May 2, 2018, 11:47 am

    @JB – could you buy a ladder of annuities as you age? with those annuities existing alongside a drawdown?

  • 57 Mark Meldon May 2, 2018, 12:14 pm

    @John B

    It’s a true story, really, he was invested, from memory, in a pretty ropey selection of insurance company funds. My story isn’t penny perfect, but it’s close enough as an extreme example.

    I’m an ‘agnostic’ on all of this. Neither annuities nor drawdown are ‘better’ – they both have a role!

  • 58 The Investor May 2, 2018, 12:26 pm

    @TheRhino — That’s currently what I think I’d do, and a solution that might suit many Monevator readers. Well, not a ladder exactly (that is when bonds run to term and are recycled) but rather phasing into annuities as I aged.

    So for instance I might look to secure my minimum income floor first: http://monevator.com/secure-retirement-income/

    … and then buy more tranches of annuities after 5 / 10 / 15 years?

    It doesn’t solve the complexity problem, but it would reduce some of the market timing risk.

    I have no idea if it’d be financially optimal-ish (haven’t modeled etc) but unlike many it seems I am most interested in the greatest chance of a good outcome in my old age, not the optimal odds for the theoretical best outcome. And “good outcome” includes minimizing risks of emotional downsides and regret. 🙂

  • 59 Mark Meldon May 2, 2018, 12:42 pm

    @The Rhino

    There are also fixed-term annuities. These generally pay a fixed income for, say, 5 years and then you have a ‘guaranteed maturity value’ and repeat the exercise. They can be useful if your circumstances change, but annuity ‘rates’ might move against you (but they could improve). They are comparable to, but not the same as, a guaranteed lifetime annuity. They were popular about 8-10 years ago as, I cynically say, they allowed IFAs another fee-earning source!

  • 60 Tony May 2, 2018, 12:44 pm

    “Remember inflation. Even today, with inflation quite low in historical terms, rising prices quickly erode the purchasing power of a fixed income. You can purchase annuities that increase in payment by a fixed percentage – usually with a maximum of 8.5% per annum – or index-linked annuities that are referenced to any increase in the RPI. In many ways, an index-linked annuity would be ideal, but they are very expensive, often reducing the ‘starting’ income compared with a fixed annuity by around 50%.”

    This is often overlooked. IMHO it’s scandalous that annuities can be sold without inflationary increases and so devalue heavily over their lifetime. Imagine if your state pension never increased. Once you’ve decided on an annuity, you have to further decide/gamble how many years you will live before an lower initial inflationary one proves better value than a fixed annuity. Many people, even with advice, aren’t able to make that sort of informed financial decision and just go for the higher initial figure.
    Separately, one advantage not mentioned, although someone alludes to it, is mental capacity. Presently, one in six people get dementia by 80. Of over 65s, 7% have it. One in three born since 2015 will get it during their lifetimes (subject to cures being developed). This website is brilliant for those who wish to and have the ability to run their own affairs to a high level. But there’s a material risk that we will be incapable of doing so. So unless you have a portfolio that will never need adjustment or rebalancing, annuities have the advantage it’s taken care for you and that additional risk is removed.

  • 61 Vanguardfan May 2, 2018, 3:13 pm

    @tony, I used to think the same as you, why would anyone want a flat annuity? Recently however I’ve read evidence that spending needs tend to steadily decline with age. This would give a good reason to go for a flat annuity – more income when you need it.

    I find it fascinating that this topic has generated so many comments so quickly.

    Only inheritance tax trumps it as a comment-generating topic! Of course, the topics are inextricably linked – especially with the new ‘pensions as perpetual generational wealth management vehicles’ policy which, I would argue, was indeed an intentional part of Osborne’s plan.

    I find it hard to comment on the annuity debate, because I have the security of enough in DB and state pensions to provide a very comfortable income floor. I don’t honestly know how I’d feel if I didn’t. I would argue however, that the main problem with annuities is their expense. So the people who can afford them are actually those that need them least.

  • 62 Mark Meldon May 2, 2018, 3:35 pm

    @Vanguard Fan

    You are in an excellent position – inflation-linked (to a greater or lesser extent) income from the state & DB pensions is a kind of paradise. DB pensions are, however, in terminal decline and most people ‘coming up’ will have to rely on the vagaries of DC accumulation and then the decumulation paradoxes in the here and now and into the future.

    I have arranged combinations of annuities/drawdown in that past; the last time we ended up with one fixed annuity, one escalating at 3% per annum compound and one linked to RPI and a meaningful flexi-access drawdown pot for those ‘little extras’.
    Something else you say is true, too.

    In my experience retirees have a bit of a splurge for a year or two, then settle down when they realise that they probably won’t ever need a new sofa again and have all the ‘stuff’ they need and then nearly always end up with excess income over expenditure (oddly enough, that can worry people too in old age!). I’m always amazed as to how little income people manage on in later life.

  • 63 Vanguardfan May 2, 2018, 3:56 pm

    @mark. Yes I’m well aware of my privileged position. I also think the DC arrangement for pensions places so much burden on the individual as to be almost cruel. I do think it’s one reason we won’t see the end of the state pension though.

    I agree with the low income requirements of the elderly. I looked after my elderly mother’s finances and even with substantial home care costs, income exceeded expenditure comfortably. And even in the ‘young elderly’ phase, the appetite for ‘stuff’ and eg home remodelling just seems to vanish.

  • 64 Vanguardfan May 2, 2018, 3:57 pm

    In fact, I don’t think DC pensions should even be called pensions, it’s very misleading. ‘Retirement savings’ would be more accurate.

  • 65 Tyro May 2, 2018, 5:17 pm

    On inheritability of pensions: this has only been in place for what, a couple of years or so? and I gather there’s already a growing view in policy circles – across the political spectrum – that it’s probably not politically sustainable. So I wouldn’t bank on it being still in place in 20 or more years’ time, when one falls off the twig.

    On the dementia point, I’ve just finished reading Jay Ingram’s book The End of Memory: a Natural History of Aging [sic: US spelling] and Alzheimer’s, in which he claims that nearly one in two over 85 year-olds has some form of dementia.

    I wonder if it would make sense for those of us who’d like our children to benefit from any ‘extra’ DC pension to use FAD initially, but put the amounts drawn down into the pensions of one’s children, and then at age 80-85 or so to annuitise the rest?

  • 66 Factor May 2, 2018, 5:21 pm

    Echoing what has been said variously in the Comments here but put succinctly, something that is a no-brainer now will perhaps, sadly, not be if you have become a “no-brainer”. Personally, I can think of no good reason for anyone not setting up a Power of Attorney (I’ve done it), and it should be sooner rather than later.

  • 67 ermine May 2, 2018, 5:27 pm

    I am old enough to remember inflation of < 25% and interest rates of 15%, and these things harm annuity incomes. That's not a reason to eschew annuities, but to keep them as part of the mix. Economies are cyclical, though the various cycles have different periods, I don't find it so hard to imagine 25% inflation, after all, there are some things from the 1970s heaving back into view in the UK political landscape.

  • 68 dearieme May 2, 2018, 5:42 pm

    “IMHO it’s scandalous that annuities can be sold without inflationary increases”: yeah, letting people have the freedom to buy the annuity they want is scandalous. How bloody dare they?

  • 69 Aron May 2, 2018, 5:43 pm

    I don’t really have anything to add to the conversation topic because I’m no where near that age yet.

    Just wanted to say that once again Mark it’s a great article, extremely engaging and informative!

  • 70 dearieme May 2, 2018, 5:56 pm

    “I also think the DC arrangement for pensions places so much burden on the individual as to be almost cruel.” I incline to that view too: it’s particularly hard on people with no experience of managing money, and more generally on the ignorant and dim. And we are all at risk of becoming dimmer.
    https://www.marketwatch.com/story/the-biggest-retirement-risk-no-one-talks-about-2014-05-08

    Still, it’s rare to see any constructive proposal on how to ameliorate the problems whether it be for people in their sixties or their eighties.

  • 71 W Neil May 2, 2018, 6:30 pm

    @Mark Interesting article thank you.

    “If you have a £500,000 SIPP fund yielding 3.5% then you might expect (I’m ignoring tax here) an income of about £17,500 per annum. That’s great, but what if your investments fall in value by, say, 25%? You then have £375,000 and that will yield about £13,125. Sure, markets might recover, but you don’t know that. With an annuity (or ‘final salary’ scheme), for better or worse, ‘what you see is what you get’.”

    I think this may even understate the downside. If we aim for a safe withdrawal rate of 3.5% over a period of 40 years, to achieve this may require 80%+ equity exposure, and possibly a rising glide path to 100%. At which allocation a portfolio fall of 40% is not totally out of the question; a real problem if it happens early in drawdown and hasn’t at least been notionally planned for with a ‘what if’ scenario.

    For a long horizon appropriate for FIRE, I am not sure inflation linked annuity rates pay enough. But I can see why they may have a place in a portfolio which is sufficient to utilize annuities to create an income floor, and where the income floor is more of a priority than the maximum potential income.

  • 72 Gadgetmind May 2, 2018, 6:37 pm

    I am now retired and have never known anything other than defined contribution AKA “saving my own money for my own old age”. This is savings in a pensions wrapper, so yes, it’s a pension. It may take some managing but we’re all adults and should be able to grasp the fundamentals of asset allocation, or just stick it all in the pension provider’s default fund, many of which are pretty decent TBH.

    Defined Benefit is dead, and should have been killed 2-3 decades earlier as it’s an unsustainable promise. Ditto the state pension and I have £0 in my retirement plans for that as anything else would be unrealistic. I regard the many 10s/100s of thousands I have paid in NI over the years as being totally lost and inaccessible.

  • 73 The Investor May 2, 2018, 7:08 pm

    “IMHO it’s scandalous that annuities can be sold without inflationary increases”: yeah, letting people have the freedom to buy the annuity they want is scandalous. How bloody dare they?

    Can we have fewer of these argumentative quips please, they don’t add anything of value.

  • 74 Naeclue May 2, 2018, 7:08 pm

    @John B, in your analysis you have forgotten about pension tax relief. In reality your £300k in a pension fund would have been topped up by 25% tax relief, so you will have £375k in the fund compared with only £300k outside, possibly less if you had to pay income or capital taxes on accumulating it.

    If you do your calculations again, but comparing flexible access drawdown from a 375k pot, you should find that the pension fund works out better.

  • 75 The Borderer May 2, 2018, 7:11 pm

    One potentially interesting use that an annuity might be put to is a buffer source of income if pursuing a dynamic withdrawal strategy. Say you adopt Guyton and Klinger’s Decision Rules, but find that, for example, not increasing your drawdown by inflation because the portfolio value has decreased creates an issue with sums available, then an annuity steps in. However, when the market is doing well, the annuity is diverted into (say) an ISA, savings account &etc.

    This way, you can continue to comply with the ‘rules’, but still achieve a more constant income.

  • 76 Naeclue May 2, 2018, 7:22 pm

    Like others, when I crystallised my SIPP, at age 55, I obtained some annuity quotes, flat and indexed and found them poor value. I am curious about fixed term annuities though and did not think to ask about them. How much would a 10 year level annuity cost for the average 60 year old? I am curious to know whether it would give a better income than a 10 year gilt ladder.

  • 77 Kraggash May 2, 2018, 8:18 pm

    Annuities would be more interesting to me if they covered ALL risk – inflation included. As the article says: “,,,an index-linked annuity would be ideal, but they are very expensive, often reducing the ‘starting’ income compared with a fixed annuity by around 50%”

    Why are they so expensive? Because they are covering the (considerable) risk of higher inflation. If the risk was not high, they would not be so expensive (I assume).

    With drawdown for a substantially equity based portfolio, you have a reasonable hope that inflation would cause asset appreciation, and consequent dividend increase.

    k

  • 78 Richard May 2, 2018, 8:49 pm

    Considering all the posts on MSE and the like asking for ways to pass on ones wealth to ones children, I’m not so sure this is that far from peoples minds (even for tiny sums). Even my parents, who are not retired and not rich and not really that interested in all this are worried their children won’t inherit their house. They see it as part of the rich mans game and to have a chance of your family ever playing it, you need to play by rich men’s rules and ensure your children get a max payout to elevate them upwards.

    I have read somewhere that you would be better off giving your kids the cash you would have spent on private schooling (assuming you are going through hardship to school privately) than privately schooling as it will have a much bigger impact on their and your descendants life (assuming they won’t just blow it on a flash car). Think what a 50 year old millionaire could offer their grandchildren as a start in life……

  • 79 Brod May 2, 2018, 9:21 pm

    Great article. Thank you very much. The comments are very enlightening too.

    We’ve had a ten year equity bull run leading to some very inflated valuations and depressed bond yields giving awful looking annuity rates, both caused by global ZIRPs. I’d like to see the comments if the same article were published after a 40/50% crash and a stagnant market for, oh, I don’t know, a decade or so while the world works off it’s debt binge. Reckon the annuity insurance policy won’t be considered so bad then.

  • 80 Hariseldon May 3, 2018, 12:26 am

    @JohnB. My comment about choosing between annuity or income drawdown from an equity portfolio in 2007 , was not about choosing 2007 as a starting date for an annuity comparison, it was when I retired!
    By early 2009 I had a near 50% reduction in the portfolio but it recovered strongly. For many people that would not have been tolerable and the annuity is the certain choice but in this case the equity portfolio has proved financially more rewarding.

    For many people the security of an annuity is very comforting and it’s the right choice, for others the more enterprising appproach is attractive. I imagine monevator readers are a subset of the population that are more likely to consider drawdown vs annuities in an informed manner.

  • 81 Gone2thegym May 3, 2018, 7:55 am

    Have been reading and praising Monevator for years. Finally my first post. A great easy reading article that has helped me reconsider the benefits of an annuity as retirement seems closer than when I started work 30 years ago for a Life company and all the subsequent changes to the industry.

    I do have an unrelated question for readers. As a percentage how much of your overall savings/ investments should be held as easy access cash. Any rules of thumb?

    Thanks

  • 82 Scott May 3, 2018, 12:11 pm

    @Gone2thegym – are you asking from the position of a retiree? Everyone should have an emergency find to tide them over (e.g. for at least a few months in the event of job loss, or for large unexpected household expenses.)
    In retirement, I have three years in cash, with another two years in bonds, the rest in equities. But I’m still youngish, and could work again if markets tanked. If I was nearer 60, and had no DB pension coming soon, I’d be holding more cash/bonds.

  • 83 John B May 3, 2018, 12:56 pm

    My cash is hardest to access, as its in p2p with extraction times in months. Otherwise I have no cash buffer, but I could put £10k on credit cards and sell equity to cover them. Now of course I can withdraw and put back in my ISA without penalty. (Or I could ask my late 80s mother, who has FAR too much in cash)

  • 84 Gadgetmind May 3, 2018, 12:59 pm

    We keep some cash to hand but also have a fully-offset tracker mortgage so could access up to £100k within a day if we needed to. We also have a lot of “unwrapped” equities and bonds (about 50:50) that we could use, but these are designed to generate tax free income as we slowly “ISA up” over 10+ years.

  • 85 W Neil May 3, 2018, 1:39 pm

    @Gone2thegym Not wanting to divert this thread away from annuities, but if you are going to hold cash and wonder how much, you need to consider the target withdrawal rate for your whole portfolio (e.g. 3.0%, 3.5%?) and for how long your portfolio needs to be sustainable (FIRE or normal retirement age), both of which are interrelated, and what is the rest of your allocation – all equities or an allocation to bonds as well as cash? Cash can be a significant drag on expected returns, especially long term, and holding too much cash could derail your anticipated SWR. This may give some food for thought https://earlyretirementnow.com/2017/03/29/the-ultimate-guide-to-safe-withdrawal-rates-part-12-cash-cushion/

  • 86 dearieme May 3, 2018, 4:40 pm

    “these argumentative quips please, they don’t add anything of value.” I think you’re wrong there. I pointed out that the poster seemed to believe that he axiomatically knew what was better for people than they did, and so he wanted a particular commercial activity banned. In other words, I was speaking up for liberty and the free market, he for some variety of authoritarianism. I can see, however, that my views might not appeal to everyone.

  • 87 Tony May 3, 2018, 5:28 pm

    @ dearieme Not at all. That’s not what I wrote nor implied. I’m making a similar point to your post 70. The free market is great for the informed and educated (those who read this site). Not so good for the average person or the time poor. FS and money matters generally are full of areas where the consumer only gets a good deal if they’re informed and pro-active. From zero interest savings accounts, energy tariffs to high fees on financial investments (the key point I’ve learnt from this website and Lars and Tim Hale’s books!) Lots of people aren’t educated or informed enough to evaluate and make rational decisions. Noone is going to ban any type of annuity. I only talk through the experience of family members. A cursory letter from their insurer and equally cursory one from an IFA outlining a fixed annuity and inflationary increased one. I don’t know enough about what regulation is in place and if and whether it should be improved but what I can say is they weren’t in a position to make an informed choice. There’s a reason the state pension does not come with two choices- fixed or increasing.
    More generally, thoroughly endorse the comments from Factor at 66 about powers of attorney. The sort of person using this website is the sort who will easily be able to fill it in themself. The Office for Public Guardian have a free helpline. But you must 100% trust the attorney.

  • 88 JimJim May 3, 2018, 5:36 pm

    I very much like this article, most people, in my experience, do not have the foggiest idea of how to manage money when they are working let alone when they retire. P.I’s are an entirely different breed. Most have a good handle on where they stand and what will be right for them at any time let alone in retirement. Forward thinking is not a thing everyone possesses otherwise how would anyone make any money at all in a stock market (losses and gains are often blamed upon sheep following the herd???) I know that an annuity is not what I need… “Final salary pensions are, in practice, annuities.
    So is the state pension.” I have enough of that already. So the market is the only other thing I need (Investment property is something I will offload as I age…I hope). It is a risk, but only for part of the plan, not all of it. What is the worst that could happen?

  • 89 Factor May 3, 2018, 6:04 pm

    @Tony (87)

    All the P of A forms, for both the Property and Financial Affairs type and the Health and Welfare type, are “downloadable” from the website https://www.gov.uk/power-of-attorney, can be completed online, and have built in safeguarding. I have both types in place.

  • 90 The Rhino May 3, 2018, 9:21 pm

    I’m currently seeing power of attorney going badly wrong on my in-laws side. With great power comes great responsibility as they say. I would reiterate the 100% trust point. Possibly up it to 110%?

  • 91 Grislybear May 3, 2018, 9:43 pm

    @ Mark, great blog and nice historical detail. There is something about those level annuties (not inflation adjusted) that troubles me. I wonder if a pensioner bought one in 1970 what would be his spending power in 1980.

  • 92 Naeclue May 3, 2018, 11:26 pm

    I have also witnessed POAs go wrong. Trust is a must, but so is competence. Also worthwhile thinking through the repercussions of appointing particular family members as POAs and any likely bad feeling this may cause.

  • 93 The Investor May 4, 2018, 12:32 am

    @dearieme — It’s not the intent of the message, it’s the short retort form. The Internet is full of people just sniping back and forth at each other. If you scroll down this thread you’ll see lots of people with a different range of views articulating their position. I don’t deny that sometimes in real life pithy is effective but on the Internet it’s just a bitchy back and forth. We’ve all done it at times, but some seem more prone to it than others. This thread is great, and I had no desire to see it get snarky.

    That’s enough about that, let’s keep to the topic please all. 🙂

  • 94 Lad's Dad May 4, 2018, 1:27 am

    I can’t help but wonder whether the minefield of utilising ones pension, i.e. drawdown vs annuities (each with their associated risks, varieties and associated conplexities), is a major factor in “one more year” behaviour.

    I know my own father is kicking the proverbial retirement can down the road partly to avoid making such crucial decisions.

    This is exacerbated by the fact he is c.7 years older than my mother. There is therefore a significant burden on making the right decision for c.10 years beyond his own life expectancy.

    On reflection, probably a position where they would significantly benefit from paying for some professional IFA advise, I think.

    Great debate by all BTW

  • 95 Gone2thegym May 4, 2018, 8:22 am

    Thanks for the input to my question about holding cash really helpful. I’m nearing 50 and taking stock of where all the time and money went since I started work. Trying to be more focused around how I manage my savings eg not leaving far too much in my current account (schoolboy error).

  • 96 Mark Meldon May 4, 2018, 9:06 am

    @The Rhino

    Hmmm..LPA’s (or their predecessors, EPA’s) can be problematic. I was a co-attorney with my mother for my late grandmother last year and she had a LOT of work to do at first when the time came to ‘switch on’ the LPA. Things did settle down and without it we wouldn’t have been able to sell Nan’s house and deal with her pensions – she lived to well over 96 and received a civil service pension for 18 years longer than she worked + state pension at Lord knows what cost.

    I have had experience where three siblings were attorney’s for their Mum. They could just not get on and agree about anything – eventually they were fired by the Court of Protection who appointed a Swansea based solicitor (with a minor criminal record!) as her Deputy instead.

    Usually, it is one’s spouse/partner that will be the ‘lead’ attorney, but remember that they are likely to be about the same age as you, so appoint a younger attorney, too. Often that will be a son/daughter (if you have children), but what about the influence of the dreaded son/daughter-in-law?

    I usually recommend a ‘neutral’ referee, such as the family solicitor as a back up as that can add a further layer of protection.

    Sadly, death is just as likely to cause arguments in families about money as divorce!

  • 97 Factor May 4, 2018, 12:13 pm

    @ Mark (96) et al

    It is perhaps worth clarifying that a power of attorney ceases automatically on the death of the person for whom the attorney is acting. Also, be aware that there is a different process for powers of attorney in Scotland and in Northern Ireland.

  • 98 ermine May 4, 2018, 12:40 pm

    Forward thinking is not a thing everyone possesses otherwise how would anyone make any money at all in a stock market (losses and gains are often blamed upon sheep following the herd???)

    Although TI has made the case reasonably well that buying and selling may be a zero sum game, the companies we invest in deliver some value to their customers. If we all agreed to sit on our backsides and tumbleweed blew through the exchanges I’d still hope to make some money from my existing holdings 😉

  • 99 JonWB May 4, 2018, 1:37 pm

    @Mark Meldon

    Thanks for the article.

    Why should you annuitise from a pension in preference to annuitising from an ISA (or any other capital source)? I’ve never seen anyone cover this point and I’m just wondering if it is something you have done or considered as an IFA. The reason I ask is that with the ISA allowance going up to £20K and the annual allowance coming down to £40K (or 10K for very high earners), the relative size of the pots for SIPPs and ISAs will probably converge compared to what they have been historically. This will likely accelerate if the flat rate of pension relief of 30% comes in, rather than the really high levels achieved through salary sacrifice with Employers NI added on top.

    To me, it just seems strange to automatically earmark the annuitisation of capital that can pass tax free to descendents (e.g. pensions) rather than considering annuitising capital that doesn’t pass tax free to descendents (e.g. ISAs), subject of course to IHT thresholds.

    I also think that for some individuals they would probably be better off downsizing and releasing equity in their homes and annuitising that capital, rather than annuitising from the pension just because ‘annuitisation from pensions is what you do’.

    I am making the assumption that ISA capital (or capital released from downsizing) converted to an annuity is not subject to income tax, but I don’t know if that is true.

    I’d really welcome your thoughts on this.

  • 100 Mark Meldon May 4, 2018, 1:55 pm

    @John WB.

    You can buy a ‘purchased life annuity’ (PLA) with non-pension fund money but the market for these is tiny, with around 100 arranged each year in the UK (or so I understand). Not so many years ago, when interest rates and inflation were higher there were nearly 100 life offices offering PLA’s, now there are only two actively in the market – Aviva & Canada Life.

    Much of the income is treated by HMRC as return of capital with only the ‘interest element’ potentially taxable, although this might be covered, in part, by the ‘personal savings allowance’. Non-taxpayers will receive a gross income. The interest element decreases with age, so many PLAs are free of tax in payment.

    You can have escalation on the payments of up to 10% per annum (certainly with Canada Life), a guarantee period (5 years, for example) meaning that if you die after 3 years the income will continue for a further 2, and ‘capital protection’. This is where the balance of the purchase price is refunded if it hasn’t been paid out as income yet.

  • 101 JonWB May 4, 2018, 2:08 pm

    @Mark Meldon – Yikes, only 100 or so, that really is a very small market. That is really useful information, thanks very much for sharing your considerable knowledge.

  • 102 Lindsey May 4, 2018, 2:18 pm

    Many thanks again for your clarity Mark – I’d no idea that the market for PLAs was quite so minuscule, which does explain why none of Monevator’s well-informed audience had hitherto responded to my plea (#12). I’m hoping against hope they’ll still be available when I’m ready to take that step in a few more years’ time, but if anyone else is ready now the only info I’ve seen is on the HL site and very hard to find, and in the past I’ve seen much more from an IFA (I assume) who was more of a specialist; not sure if I’m allowed to post the name here, or even if he’s still active.

  • 103 Mark Meldon May 4, 2018, 3:40 pm

    Her is a bit more on Purchased Life Annuities – the ‘forgotten annuity’ – which might be of interest (with thanks to my friends at Canada Life for the ‘aide memoire’).

    PLAs are available on a single life, joint life and ‘life of another’ (see below) basis.

    The regular income can be paid for life or for a fixed period (Trollope again https://en.wikipedia.org/wiki/The_Fixed_Period – rather an apt book (which I have yet to read) for the subject in hand!).

    A ‘Life Annuity’ pays an income throughout the life of the annuitant. In the case of a joint life annuity, payments will continue until both annuitants have died.

    The ‘Temporary Annuity’ pays the income for a specified number of years, or until death, if this occurs before the period has expired.

    Main uses for the PLA.

    Apart from providing a guaranteed income from capital, a PLA can have specific applications:

    Funding school fees using a temporary annuity based upon the child’s life. It is possible to receive an increasing income to allow for future fees inflation.

    Enhancing a retirement provision by converting part or all of Pension Commencement Lump Sum (tax-free cash) into a life annuity, which has tax advantages as part of the annuity is not subject to tax.

    When taking early retirement, using a temporary annuity to cover a possible shortfall in income until State Pension Age.

    Funding the premiums of a life assurance policy for inheritance tax payments from a life annuity or temporary annuity, often known as a ‘back to back’ annuity.

    Reducing the value of an estate, thus saving on inheritance tax, by purchasing an annuity.

    Canada Life has a minimum age at entry for a lifetime annuity of 35 attained, with a maximum entry age of 94 years, 11 months. Annuities are arranged on younger lives sometimes as part of a ‘structured settlement’ after a serious injury or illness. There is no minimum age for a temporary annuity and the same maximum age as before.

    Life offices will not arrange PLAs for the over 80s unless they take out one of the two generally available death benefit options.

    A ‘guarantee period’, where payments are guaranteed for a number of years to a maximum of one year less than the duration of a temporary annuity. In the event of death(s), income payments continue throughout the remainder of the guarantee period.

    ‘Premium protection’, where death occurs before the sum of income payments made to the annuitant(s) is equal to the purchase money, this will pay the difference as a lump sum.

    These ‘insurance options’ are paid to the annuitant(s) personal representatives.

    When a joint life annuity is arranged, it can be set up so that income payments continue on a reduced basis on the death of one of the annuitants. With this option, a higher income can be selected to be paid while both annuitants are living. It ensures that the annuitants receive payments which more closely match their needs at the time; normally higher when both partners are living; lower when there is only one. The facility can be designed to come into effect on the death of either person, or designed so that the reduction occurs on the death of one specific annuitant (where a pension might continue, for instance).

    Escalation can be chosen, where the payments rise on each policy anniversary, at a fixed compound rate, sat 5% a year.

    The greater the optional features that are built into the annuity, the lower the annuity.

    The minimum purchase price for a PLA is generally £10,000.

    There are, I think, three main financial planning opportunities where a PLA should be considered; the examples that follow assume that the clients are a married couple (for the sake of clarity).

    ‘Life of Another’. Where a wife is younger than her husband it could benefit her to take out an annuity in her own name, but based on the life of her husband, who will be the annuitant. That way, the policyholder can take advantage of the higher rates which apply to older lives, while receiving the income themselves.

    Also, where the husband is a higher rate taxpayer and the wife pays at the starting or basic rate or is a non-taxpayer, it could benefit the wife to take out an annuity in her own name, but based on the husband’s life. This will ensure that the taxable portion of the annuity income, called the interest element, will not be taxable at the higher rate. It will be taxed at the basic rate (currently 20%), or will be tax free, depending on the tax status of the wife.

    However, where life of another is used and the annuitant (the person on whose life the policy is based on) is older, please note that this could outweigh any taxation or rate advantages. This is because under normal circumstances the older person would die first resulting in the income stopping earlier, unless a life insurance could be arranged to cover this risk.

    ‘Planning for school and college fees’. Where a parent buys an annuity in the name of their child, the income is treated as part of that parent’s income.

    The parent who pays a lower rate of tax should consider buying the child’s annuity, so that the income is subject to tax on the interest element at the lower rate. When capital is gifted to a child from someone other than the parents, such as a gift from grandparents, the income from a PLA subsequently purchased is not considered as that of the parents, but is treated separately under the child’s personal allowance.

    ‘Back to back annuities’. A back to back annuity is one where the regular income received from the plan is used to pay the premiums on a separate life policy.

    Back to back plans are especially attractive where the annuity can be paid gross to a non-taxpaying spouse. The spouse will then have more cash available to fund the life policy.

    As I have said, these things are old-fashioned, but reliable, and hardly ever arranged nowadays – do remember them though!

  • 104 SurreyBoy May 5, 2018, 12:27 pm

    Ive been looking at Investment Trusts for income lately. Im in the accumulation phase but can see the day coming where there is great appeal in switching the various ISA funds into dividend hero ITs. The Greybeard articles informed this thinking.

    In theory (and i know its not guaranteed at all) these Investment Trusts should throw out a starting yield which should pace or exceed inflation over the long term. When markets plummet, i understand the IT reserves are used to maintain dividend flows – so whilst the value of the ITs will tank in a crash, the income should remain there – albeit it may reduce for a while before hopefully rising as markets heal.

    I know annuity represent absolute certainty but would income focused Investment Trusts represent a solution for those who want income but cant face the perceived poor value of gilts?

  • 105 The Accumulator May 5, 2018, 1:43 pm

    @ All – what a great comment thread! Like a bonus article all by itself.

    I helped my mum cover her finances in retirement with escalating annuities covering annual income needs, a small cash buffer for emergencies, and anything left over invested in a LifeStrategy fund. Purchase Life Annuities formed part of the mix. Mum before = highly stressed about finances. Mum after = lives happily within her income, no more stress (about finance).

    I should point out, that while mum is highly capable, she is risk adverse and has zero interest in investing / managing a drawdown portfolio.

    @ Mark – thank you very much for sharing your advice and expertise. It’s instructive to hear your anecdotes, especially because annuities seem a little arcane and much of the debate gets framed in terms of ‘optimisation of theoretical results’ rather than ‘optimisation for peace-of-mind’.

  • 106 Atlantic May 6, 2018, 1:22 am

    @SurreyBoy
    While investment trust companies have reserves salted away to continue to pay dividends, I would have a question mark as to whether they would all typically have enough to continue paying dividends through a prolonged market downturn lasting a few years. Once they’ve used up the reserves they will depend on the current income they’re receiving from the companies they invest in and if that drops then the dividends they’re paying out will drop too. However that said, there are several “dividend hero” investment trust companies that have managed to increase their dividend payouts for decades without a break. I retired 2 years ago and transferred my SIPP into income drawdown, invested mainly in investment trust companies. The balance I kept in cash in the SIPP representing 3 years income (my income needs are modest, this is not a huge amount). While most academic studies are very negative on holding cash, it helps me sleep better at night. I reckon in the event of a market crash, the cash element of the SIPP and the dividends from investment trust reserves would carry me through at least 4 years without having to sell shares.

  • 107 Atlantic May 6, 2018, 1:37 am

    @SurreyBoy
    I forgot to add to my last post that I looked at annuities after going into income draw down. The best annuity quote I got gave an income that was a good bit less than the natural dividend income arising from the investment trust portfolio in my first year of investment, albeit the dividend income is not guaranteed while the annuity is. I do plan purchasing a small annuity at age 65 or 66 using an untouched pension fund to beef up the state pension.

  • 108 SurreyBoy May 6, 2018, 11:48 am

    @Atlantic – thanks. On the point about a cash buffer, i think im with you in that it would help me sleep at night to have one. Ive read various articles on how the buffer is a drag on returns over the long term and so on, but the more i contemplate the practicalities of RE the more benefit i see in sleeping soundly.

  • 109 Kraggash May 6, 2018, 12:02 pm

    @Atlantic “The best annuity quote I got gave an income that was a good bit less than the natural dividend income arising from the investment trust portfolio in my first year of investment”

    A better comparison would be with the income from your IT portfolio PLUS cash buffer. You would need a much smaller buffer with an annuity!

  • 110 Mike May 10, 2018, 1:23 pm

    Never been a fan of annuities. But, this is a thoughtful post…appreciated.

    IF (emphasis on IF) the next 10 year’s market returns were going to be as modest as many (Vanguard, included) predict, I believe your point (to me) would be a Fixed Immediate Annuity is worthy of consideration (I’m a 65 year old, single male…excellent health). That is, protecting a significant % of nest egg from extended or deep bear market would be “cheap” relative to predicted market returns.

    EXAMPLE: A $500k fixed immediate investment annuity would yield 6.61% — $2,800/month…$33,600/year.

    Are we “on the same page”?

  • 111 Nick Lincoln May 12, 2018, 9:56 am

    Short counter-argument: in 1988 a first-class stamp cost 19p. Now it’s 64p. Fixed income = fixed outcome: penury.

    Longer counter-argument: if you think you are going to live an average retirement of c.30 years then drawing on a pot of equities to fund retirement makes sense.

    Ignoring dividends (!) the FTSE-AllShare has never lost money over any rolling 30 year period. In every sense of the word, there is no “risk”. There are just temporary declines, quickly reversed. How the investor emotionally reacts to these temporary declines will determine the investment outcome, not the markets themselves.

    At 4% trend inflation, living expenses more than quadruple over 30 years. That is the reak risk that retirees are exposed to. Over the last thirty years, the total return of the FTSE All-Share has been an annual premium OVER inflation of 6%

  • 112 Rio Nido September 30, 2018, 7:04 pm

    The “problem” with annuities is that often they are portrayed as investments when they are actually “longevity” hedges. Yes they are sold rather than bought but argument can be made by financial planners or anyone really that some portion should be allocated. Not an either/or decision.

  • 113 Kate White October 27, 2018, 2:34 pm

    Ref. whether to go for an annuity or not. Is there such a thing as a protected annuity? What guarantees do I have if the company that provides my annuity goes bust? Is there something equivalent to the FCIS or the government’s pension protection fund? Otherwise, as I see it, I hand over all my pension to a company and trust that 30 years later they’ll still be able to pay me !!

  • 114 The Investor October 27, 2018, 4:59 pm

    @Kate — Hi, an annuity from a regulated provider should be 100% protected by the Government under current regulation:

    https://www.fscs.org.uk/what-we-cover/pensions/compensation-limits-for-pensions-retirement-savings/

  • 115 Kate White October 27, 2018, 5:58 pm

    @The Investor – thank you for this speedy response. Have looked at the FSCS (not FCIS, my mistake, ha) info and there is indeed 100% FSCS protection for an annuity, making it a guaranteed income for life.

  • 116 J.D. May 4, 2019, 12:19 pm

    You said

    “””
    how ridiculous it was that the retired had to spend so much time thinking about their investments, taking and paying for advice, and worrying about the stockmarket. I said I thought that for many it would be much better to cover their financial backsides with a lifetime annuity.
    “””

    The problem is, even with annuities, the person still needs to learn all about it, because “financial advisers” often push clients into other annuities where the adviser makes more money and couldn’t possibly care less about the detriment to the client.

  • 117 Goku May 21, 2022, 7:54 am

    Wort a revist in light of the current inflation figures?

  • 118 Mark Meldon May 21, 2022, 10:19 am

    Hello, Goku.
    I think that’s a good idea, especially as annuity ‘rates’ have improved significantly since I wrote this piece as bond yields have risen. In the last 18 month’s or so, I’d say that the majority of pension annuities that I have arranged have been ‘real annuities’, i.e. those linked to the RPI. right now, that seems a very good decision, but has to be contextualised with the individuals other retirement income streams.

  • 119 Mark Meldon May 21, 2022, 2:10 pm

    Just a quick annuity rate update. Assume an individual who had just turned 68 decided to buy an annuity for him/herself with £100,000 from a pension fund. The annuity would include a 5-year guarantee period and be paid monthly in advance. Assume further a typical 1% adviser charge is taken from the pot.

    Today, the best offer for a fixed, level, annuity is £6,279.00 p.a.
    The best offer for an annuity linked to the RPI is £3,677.44 p.a.

    With inflation what it is today, I’d argue that the RPI annuity is rather good value.

  • 120 Norman October 7, 2022, 8:34 pm

    @Mark Meldon – thanks for the initial article and update. In this period of rising interest rates, inflation and increasing gilt yields, is it reasonable to expect annuity rates to improve even further in the short term?

  • 121 Mark Meldon October 8, 2022, 5:48 pm

    @Norman. Quite possibly. Since writing the above brief update, the ‘rate’ on RPI-linked (“real”) annuities has increased by an astonishing 77%.

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