Growth of the annuity market - Over the next five years, the ‘at retirement market' is predicted to grow to £23.1 billion, so it is hardly surprising that so many retirement products such as variable and fixed term annuities have launched into the annuity market in recent years.
The term ‘third way' has come into regular usage, indicating a different way of drawing retirement income from the more traditional routes of conventional annuity or income drawdown.
However, there is a type of annuity which has been widely available since the early 1990s - the with-profits annuity. A with-profits annuity offers a level of guarantee to a client's income, but also has the potential for growth, linked as they are to the provider's with-profits fund.
For clients who have chosen their provider well, with-profits policies have delivered attractive increases in income to clients. For example, a client taking out a with-profits annuity 15 years ago with Prudential could have seen their income increase almost three-fold during that time period*.
Recent innovations in this sector have seen further improvements to the traditional with-profits annuity. Prudential launched the Income Choice Annuity earlier this year with a simplified bonus structure, increased income flexibility and a ‘factory gate' approach to adviser remuneration, both on an initial and ongoing basis.
Why a conventional annuity is not always the best route
75 per cent of funds and almost 90 per cent of individuals who reach retirement choose to purchase a conventional annuity. Clearly this is the right route for some, but perhaps not as many as this.
Firstly, the notion of risk must be quantified. Although a conventional level annuity can provide certainty over the amount of monetary income, it should be remembered that increasing longevity means that inflation will have a significant impact on buying power over time.
Secondly, is adequate allowance being made for any dependants, particularly a spouse? Many annuities are set up with no dependant's pension even though there is a spouse or civil partner.
Both of these situations clearly represent a different type of risk - the risk of living too long in the first example and dying before the dependant in the second. A with-profits annuity can help balance these risks by providing the potential to keep pace with inflation, but with a level of starting income similar to a single life annuity and with an element of spouse's protection. The trade off is a degree of investment risk, but many may view this as acceptable given the potential impact of longevity and inflation.
So why choose a with-profits annuity?
Subject to the client's personal circumstances, starting income can be very attractive, and could be around 20 per cent more than could be achieved from a conventional level annuity. If your client qualifies for an enhanced life annuity, income levels could be boosted further.
For those who may normally choose an escalating annuity, a with-profits annuity can also be an alternative. The minimum starting income is similar and, crucially, some providers give a guarantee that income cannot fall below this level, regardless of future investment returns. So, for annuitants looking for an income that has the potential to increase and has a minimum guarantee, they can be an excellent option.
With-profit annuities can also be a useful exit strategy for income drawdown. Annuitants purchasing a with-profits annuity at age 75 can do so with a 10 year guarantee, often making it a more attractive option than alternatively secured pension (ASP). At this age, some clients will also qualify for an enhancement to their income on health grounds. Remember too that you can retain annual remuneration, enabling advice to be given on an ongoing basis. More modern with-profits annuities, such as the Prudential Income Choice annuity, retain a level of income flexibility which could be important - with a maximum level of income in excess of an ASP.
Even at relatively modest sums, with-profits annuities should be considered - after all a client with, say, £25,000 in their hard-earned retirement pot may need to make the best possible use of their fund in terms of income provision. For some, a with-profits annuity can provide an important part of a portfolio of retirement products, perhaps as they start to "phase out" of drawdown at age 70. They could also be used in conjunction with a conventional annuity to provide the potential for growth and a high level of guarantee. Another option is that they might be used in conjunction with an income drawdown arrangement to reduce investment risk to the client.
For those looking for the potential of a growing income but also with a guarantee and future flexibility of income with-profit annuities can provide an ideal solution.
*According to Prudential's historic bonus calculator with a start date of 1 November 1994 and assumed bonus rate of 0 per cent.
