Earlier this year we highlighted how annuities were making something of a comeback.
That has continued in line with rising interest levels.
They fell out of favour because rates were on the floor and drawdown meant the saver was in control, and able to hand their pot, or part of their pot, to the next generation. Once purchased, annuities can’t be unwound, so people feared being stuck with poor income figures. However, with drawdown, your money remains invested and subject to the vagaries of the stock market. Hence, those who prefer certainty, wanting a guaranteed income for life, have been looking anew at the merits of annuities.
Annuity providers buy government bonds to generate returns. Low interest rates push these returns lower; conversely, higher interest rates see them edge higher.
And, with the Bank of England likely to increase rates further, the trend is set.
This leaves retirees with a dilemma.
Opt for drawdown and be a prisoner of volatile stock markets or seek the security of annuities but risk inflation eating away at your income.
This Is Money recently set out a fuller picture of the pros and cons of income drawdown and annuities.
Drawdown offers you the flexibility to alter withdrawals to suit your needs, so if your circumstances change you can adjust. You also benefit from long-term growth. Death benefits rules are extremely attractive. If you die before age 75, you can pass on any unused funds to your nominated beneficiaries tax free. If you die after 75, any inherited funds will be taxed in the same way as income when your beneficiaries make a withdrawal. Potential cons are having to manage your withdrawals sustainably so you don’t run out of money, plus accepting investment risk, which in turn means the value of your fund could go down as well as up.
The main strengths of annuities are the security of income they provide and the fact they do not require any ongoing engagement once selected. On the downside, annuities are inflexible and once you lock into an income, there is no going back. This means if say, you fall into ill-health and need to pay for care – your income will not be able to adjust.
Still in a quandary?
Another approach is to seek the best of both worlds.
For example, combining a minimum level of guaranteed income via a fixed term or lifetime annuity, while leaving the remainder of your fund invested and producing a variable income.
AJ Bell looked at how a 65-year-old with a £200,000 pension pot could opt for a 50/50 split between annuity and drawdown.
A £100,000 drawdown pot might provide an inflation-linked income worth £4,918, assuming five per cent investment growth annually, withdrawals increasing by two per cent each year, and the fund running out after 30 years. The remaining £100,000 could buy an inflation-linked annuity for you and your spouse worth between £5,198 and £5,970 per year.
Tom Selby, AJ Bell head of retirement policy, told This Is Money: “While annuities and drawdown are sometimes viewed as an either/or choice, it can make sense to combine the two to create a retirement income plan that suits your needs.
“An annuity and state pension could be used to cover fixed costs, with the rest of your fund benefiting from the flexibility and growth potential of drawdown.”
Consider too buying an annuity with a ‘guarantee period’, which protects against the loss of all or most of your purchase money if you die shortly afterwards.
As we warned last time, always shop around before buying an annuity – it is an irreversible decision.