Annuities safer than sports cars
PENSION savers have been told to keep faith with annuities after a dramatic slump in sales since the government unveiled plans to open up access to pension pots next year.
Insurance giants L&G and Prudential have both reported 43 per cent falls in annuity sales for the first half of this year, while retirement specialist Partnership has seen a 50 per cent plunge over the same period.
The collapse in the take-up of annuities – used by the majority of retirees to convert their pension pot into a regular retirement income – was triggered by radical pension reforms set out in the March Budget.
The biggest change, taking effect next April, will allow retirees to take their entire pension pot as a cash lump sum, including 25 per cent tax-free. The remainder will be taxed at the individual’s marginal rate, rather than the current 55 per cent charge that effectively forces many people to buy an annuity.
Reforms already implemented have made it easier to enter drawdown – where income is taken from pensions that remain invested – and to cash in small pension pots.
In March, pensions minister Steve Webb caused controversy when he said it was people’s “choice” whether to buy Italian Lamborghini sports cars with cash released from their pension pot.
The government’s Budget gambit came weeks after the City watchdog warned that the annuities market was “not working well for consumers”. It was the latest in a series of reports revealing the extent to which people were being ripped-off by annuity providers.
But experts fear that too many savers are now overlooking the security offered by annuities, with potentially costly results.
Carl Melvin, director of Renfrewshire-based Affluent Financial Planning, said: “Annuities should not be forgotten, as this is the most effective way of ensuring lifelong income with minimal risk, and given the opportunity, everyone would want stable reliable guaranteed lifelong income.”
Annuities do still offer fair value, according to a report published by the International Longevity Centre earlier this month. It found that the long-term fall in returns from annuities resulted largely from longer life expectancy, which means that payouts are stretched out over a longer period.
“The security and certainty of annuities is under-appreciated,” said Melvin. “People don’t think they will live long enough to get value from the annuity so they focus on the loss of capital value if they were to die shortly after annuity purchase.”
The looming overhaul has also prompted large numbers of people to defer buying an annuity. However some will lose out from doing this, warned Graeme Mitchell, managing director at Lowland Financial in Galashiels.
He pointed out two potential risks from deferring. One is the risk that they remain invested and their fund falls in value.
“That means they would have been better taking the tax free cash and buying the annuity now – the bird in the hand option provided an annuity is definitely the right thing.”
The other risk is the potential for annuity rates to fall significantly.
“You would expect annuity rates to improve if interest rates rise, but there could be pressure on annuity rates if markets shrink, companies become less focused in this business and competition reduces,” said Mitchell.
In some scenarios it could take up to 40 years to recoup the income lost from delaying annuity purchase, retirement specialist MGM Advantage has estimated.
But deferring will for some people make sense, Mitchell added, such as where there’s a tax advantage to be gained. “It might be better to have income in the next tax year if it will be taxed at a lower marginal rate. It might also make sense to defer if you have safe growth built into your existing plan, which means you remove the market risk,” he said.
Then there’s the possibility that insurers will develop more innovative products that serve as a good alternative to annuities. But the Financial Services Consumer Panel has warned that providers could develop inappropriate products to replace the lost revenue from annuity sales, increasing the risk of mis-selling.
The primary alternative to an annuity is a drawdown plan, which comes with the risk of investment losses.
“For those who cannot afford such risks, the annuity offers a safer (albeit poorer value) option,” said Melvin. “However, for those with reasonable sized funds and other assets, drawdown will appeal – certainly the flexibility, control, better death benefits all offer what annuities do not.”