Why are annuities making a comeback for pensioners?

As the market has developed in recent times, annuities have seen something of a revival, with sales increasing.

To find out what is behind the comeback, we decided to poll users of our Guiide site. We asked if they would like to use a proportion of their fund to secure a guaranteed income.

The answer was quite surprising, with nearly 50 per cent saying yes. Among those that said yes, the most popular level of guaranteed income was using around one-third of the total pension pots to secure some guaranteed income.

Pooling your chance of surviving to old age with a group of others — the essence of annuities — has a real financial benefit to people

For the purposes of ensuring a secure retirement income, I have always been a fan of annuities. They give you a guaranteed income for life, no matter how long you live and no matter how volatile the investment markets become.

Another often overlooked benefit is that you do not have to think about an annuity. You buy one and that is it — you just get paid. There is no monitoring investments, no worrying about how much you can take each year, it is just money in the bank each month.

The revolution of drawdown

The problem with annuities has always been that they are inflexible — as they are meant to be. When drawdown was opened up to everyone, it was a revolution, but with that flexibility came a huge amount of problems.

Managing a drawdown strategy on your own is very hard. You can pay for advice, but around half of those taking drawdown do not. For these retirees, it means an awful lot of risk and work in determining where to invest, how to take your money each year, tax issues and more.

But most of all, the difficulty lies in not knowing how long your pots need to last. No one knows how long they will live and therefore for how long they will need their pots to last.

Tables and projections from the Institute and Faculty of Actuaries show that 250 out of 1,000 average 60-year-olds are expected to die before age 81. Around half will live to 89, a lucky quarter will get to age 94 and a very lucky 100 out of the whole 1,000 will make it to age 98.

While it is relatively easy to predict the deaths at various ages of a large group of people, it is very difficult for any one average individual. There is such a large range of outcomes, that being certain of taking the right amount of money from your pots to cover everything you need today, without running out tomorrow, is just impossible.

Even using the average projected life expectancy (89 from the numbers above) to target how long you need your funds to last, means there is still a 50 per cent chance you will need your pots to last longer.

In other words, one in every two people would run out of money if they use this as a calculation. Pooling your chance of surviving to old age with a group of others — the essence of annuities — has a real financial benefit to people.

Essentially, you get a survival bonus each year that dwarfs expected investment returns at later ages. Many annuities come with guaranteed lump sum payments on death and a surrender value, so that if your health takes a turn for the worse, or your financial circumstances change, you can get some of your money back.

Life choices for retirees

The Work and Pensions Committee’s recent report, Protecting pension savers — five years on from the pension freedoms: Accessing pension savings, came up with a clear conclusion, among others, that retirees should use a combination of products, not just one, such as drawdown to provide an income.

Many seem to now be doing or considering this, perhaps guaranteeing their “must-have minimum” income, and leaving the rest to be taken flexibly, or if they have more than enough using drawdown projections, reducing risk.

The shiny new pension freedoms are great, but now that retirees are realising the reality of the risks and difficulties of managing a drawdown portfolio alone, annuities are — and will, in our opinion — continue to make a comeback.

Kevin Hollister is a pensions actuary and founder of Guiide