I think the changes announced by Chancellor George Osborn in his Budget on 19th March 2014 will either kill or cure the annuity – my best guess is that it is likely to be the former, but what do I know ? !!!
Traditionally annuity rates have been based on the long term trading value of gilts. With interest rates dragging along the bottom for a number of years, the return on annuities have been a big casualty. Annuity rates have been in general decline for many years (even during times of good financial returns) and it is hard to see them making such a recovery in the short term that they are likely to become a significantly more attractive proposition over the coming months and weeks.
Even if annuity rates were now to double (which is extremely unlikely) people who are already in an annuity would not see any benefit, as the annuity is based on the rate you received when you took out the annuity. Future annuity rate ‘ups and downs’ will not affect annuities already in payment.
Likewise waiting for annuity rates to increase could be a risky option. If you were to wait say 1 year before the rates went up, the increased annuity payment may never be enough to cover the income lost during the 12 months when you could have taken an income but didn’t (cost of delay).
The way the announcement was made and reported has also, in my view, painted annuities in a very bad light and in my experience, the fact that people will have direct access to their fund and not have to give it to an annuity company, is likely to be a very popular decision. This new legislation does not come into force until April 2015 and this again will make annuities, in my view, redundant for at least 12 months if not longer. Effectively the Chancellor has said that from April 2015, everybody with a defined contribution pension is in Flexible Drawdown by default.
The Regulator has been interestingly silent on these changes. Up to this point they have been very concerned that people with funds worth under £100,000 (the vast majority) should not be going into Drawdown – In such a situation the Regulators position has been that unless there a very specific reasons for using Income Drawdown, an advisers default position for such people should be an Annuity - now the Government effectively says that we are all in Drawdown and it is absolutely fine to spend all of your pension fund in one go – if you want !!!
What shouldn’t be overlooked is the fact that these changes will have a major impact on the profitability of those insurance companies currently offering annuities. We have already had customers who were perfectly happy to buy an annuity on Monday put the brakes on the transaction after the budget. Without doubt, these insurers will look at redefining existing products and may even introduce new ones that make the idea of giving them your pension fund in exchange for a long term secure income significantly more attractive However as already stated, I believe it will be quite some while before any new products in this area are launched.
So the dilemma for people who need an income right now is what should they do ? None of the following are specific personal recommendations - but they do reflect the current options open to customers.
- If the customer is happy with the annuity income they are being offered and like the security for life offered by an annuity then this may be the most suitable option for them. The downside is that they will not be able to take advantage of any new products or improved rates that could come along in the future.
- They could go into standard drawdown. The increased maximum GAD rate of 150% takes effect from 27th March 2014 – In our experience this 150% GAD rate is likely to provide significantly more income than available from a Standard annuity and potentially more than available for an enhanced annuity for people with impaired lifestyles. The money in the drawdown remains invested and gives the customer the opportunity of growing their fund while also taking an income from it – although this cannot be guaranteed. The customer can leave the Drawdown product at any time and transfer to an alternative retirement product of their choice. This means that if improved annuity based products become available the customer can leave and take advantage of them.
- The customer could take a temporary annuity for three years or longer. The temporary annuity will provide income up to the new maximum 150% GAD level and return to a customer a guaranteed maturity value at the end of the term. Again the customer can then take advantage of any retirement product that may be available at the time. Customers who take the minimum three year term are unlikely to see any growth on their pension fund (they are likely to get back the original fund value less any income or lump sums taken) however customers who are prepared to take longer terms of 10 years or more, would see underlying guranteed growth in their fund. The maturity value is guaranteed at outset and cannot be affected by fluctuations in the investment markets.
- There are With-Profits and Unit Linked annuities on the market. These offer the potential to grow income over time while offering a minimum income that cannot be removed – however like a standard annuity these products tend to lock the customer in for life.
This is undoubtedly a confusing time for customers who need to realise an income from their pension fund at this moment in time. If you need to take an income now then the options above are your only options.
Coming back to the original question – I don’t believe annuity rates are likely to improve in the short term and there is a risk that annuities as we know them become obsolete for the vast majority of customers. This is likely to reduce the number of companies offering annuities – which has also been a growing trend in recent years.
I hope this gives you some food for thought and help you make an informed decision. If you want to discuss this article further please call us on 020 33 55 4827