When it comes to retirement income, there are normally two choices for advisers and clients.

The first choice is an annuity where income is secure and paid for life or a fixed term in exchange for a capital sum passed to an insurance provider.

The second is income drawdown where income is not secure and investment risk has to continue into retirement but full access to the pension fund is retained. Both have advantages and disadvantages.

The past

For a significant period of time from 2008 to around the beginning of 2022 annuity rates had been on a downward trajectory with the bottom occurring in the middle of 2016.

For many retirees during this period, there was little value in purchasing an annuity. Investors were instead prepared to take the risk of income drawdown believing that a better overall outcome could be established via investment in financial markets, over what an annuity could provide. For most this was true.

Added to this, the introduction of pension freedoms in 2015 gave retirees more flexibility and control over their income, with the added benefit of being able to leave the pension fund to loved ones without any inheritance tax.

Income drawdown was therefore the favoured route; annuities just did not really stack up except for the most cautious individuals or those with limited wealth.

The present

Over the past few years, there have been a number of events that have changed this landscape.

The Russian invasion of Ukraine in 2022 led to a return of rampant inflation, especially in the energy and food sectors. This led to the Bank of England increasing interest rates quickly. This feeds through to gilt yields and thus to the rates that apply to annuities, making them more attractive.

Then in the first Budget since Labour took power, the rules surrounding pensions and inheritance tax changed. From April 2027, pension funds will form a part of an estate on death, making pensions less flexible and more highly taxed. As a result, they are going to be less efficient for leaving legacies.

The final piece of the jigsaw concerns investment markets which have been on a very good run of late, meaning that pension funds are ‘healthier’. So swapping some of the accrued value and profit for a guaranteed income has an added attraction.

The future

This has led us at Colmore Partners to take a greater interest in annuities for our clients, doing some deep research into where they might fit and considering the available options.

As a starting point, it is our view that having some form of inflation-protected guaranteed income which covers core expenditure is a sensible position.

Options

There are many options with annuities, so it is important to take advice. We have studied and provided some analysis of short-term annuities, and a recent product innovation provided by Standard Life, in conjunction with Fidelity – the Guaranteed Lifetime Income product.

Conventional annuities

Conventional annuities are annuities in the traditional sense where an income for life is purchased in exchange for a lump sum and once in payment it cannot be changed. The income is paid for life on single or joint lives and can be level or increasing in payment.

Rates on conventional annuities have increased significantly as is illustrated by the numbers below assuming a £100,000 purchase price:

Male 65, payable on single life only, level in payment = £7,429 gross p.a*.
Male 65, single life only, increasing by RPI in payment = £4,991 gross p.a*.

The main advantage of this approach is that a guaranteed income for life is created with no investment risk attached, offering greater security.

The biggest disadvantage is the impact of longevity uncertainty. In practice this falls either on the short side (the insurer wins) or the long side, if inflation-protected increases are not provided.

Short term annuities

Short or fixed term annuities are a guaranteed income for a set period of time, with a guaranteed maturity value that is calculated at outset. Due to the current yields available on gilts, there are some quite interesting numbers here.

Male, 65, single life, level, 10-year term, £100,000 maturity value = £5,256 gross p.a*.
Male, 65, single life, RPI, 10-year term, £100,000 maturity value = £4,338 gross p.a*.

In both of these examples the maturity value after 10 years is the full repayment of the initial investment of £100,000.

The main advantages of these products is the guaranteed income that is provided for a fixed term, with a maturity value that is known at the outset. This gives people the ability to plan and bridge short term gaps in income, for example to avoid early retirement penalties on other pension income.

The main disadvantage with these annuities could be the impact of inflation during the period in question, or movement in markets that could impact the position on maturity. For example, if investment markets or annuity rates move against you in this period weakening the potential outcome at maturity.

Guaranteed Lifetime Income

This is a product where an annuity is purchased within an income drawdown contract. The income is paid into the pension and not direct to the annuitant.

It provides a guaranteed income stream where the actual payment of the income is flexible and under the control of the individual meaning tax can be managed.

Male age 65, single life, level = £7,492 gross p.a*.

The main advantage of this is it provides guaranteed income, but with additional flexibility. It allows control over the income payments and the tax, or the option to re-invest the income payments within the pension fund; it is a good halfway house and could be useful for de-risking portfolios.

The main disadvantage is with respect to the income, which is level only, so has no inflation protection and other inflexibilities over how the income can be shaped in payment and how spouses can benefit on death.

Conclusion

I have tried to give an overview of the main points concerning each option discussed, but there are clearly many nuances. It’s essential to look at each individual on a case-by-case basis to give a suitable outcome.

As discussed, there has been a significant shift in the retirement landscape recently, which has meant that annuities should be properly assessed as a part of a retirement portfolio for some or all of the wealth in question.

It seems difficult to argue that there is not a place currently for some form of annuity to provide an element of income security in retirement.

The questions that need to be asked are: when is the appropriate time (i.e. at what age does it make sense); how much income is secured; and what annuity is the best option.

Everyone is different and has different needs so there is not an answer that fits all which is why it is necessary to seek advice for your specific circumstances and needs.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.

Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances.

Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.

Your pension income could also be affected by the interest rates at the time you take your benefits.

The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future

Colmore Partners is a registered trademark (a trading name of Colmore Partners Limited) and an appointed representative of Best Practice IFA Group Limited, authorised and regulated by the Financial Conduct Authority.

*Quotes are indicative, based on standard rates, and are subject to application and underwriting. They are offered only for general informational and educational purposes. They are not offered as and do not constitute financial advice. You should not act or rely on any information contained without first seeking advice from a professional.

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