As falling bond and gilt yields cause conventional annuity rates to continue to decrease, with-profit annuities are becoming more popular with both advisers and consumers, claims Prudential.
Following the publication of Prudential’s first Annuities Index based on research by Defaqto, the insurer claims pensioners choosing a conventional annuity are 4% worse off than pensioners retiring a year ago because of the decline in annuity rates.
According to the research, based on the purchase of a £100,000 conventional annuity, a 65 year-old man would retire today on an average annual income of £6,540 compared to £6,730 a year ago, representing a drop of £190 or 2.8%.
Meanwhile, a 60 year-old woman can expect an average annual income today of £5,330 compared to £5,550 in 2005, which is a drop of 3.9% or £220 in the space of just 12 months.
Conventional Annuity rates based on level open market option annuity of £100,000
|Conventional Annuity Rates||Male Aged 65 Now||Male Aged 65 2005||Woman Aged 60 Now||Woman Aged 60 2005||Joint Life Male 65 / Female 60 Now||Joint Life Male 65 / Female 60 2005|
Prudential argues this decline is helping to fuel an increasing interest in with-profit annuities, which is being driven by the chance the annual income can increase as the fund remains invested in an actively managed with-profits fund.
As a result, it says it has seen its sales of with-profit annuities double in the last 12 months to March 2006, as clients choosing an anticipated bonus rate of between 3% to 5% receive a higher starting income than those on conventional annuities.
Annuity income in 1st year from £100,000 for a 65 year old man
|Type of Annuity||Conventional||WP 3% ABR||WP 5% ABR|
|1st Year Income||£6,540||£6,981||£8,406|
Aston Goodey, head of retirement for Prudential, says pensioners retiring today are receiving lower incomes than those retiring a year ago because the declining gilt and bond market yields have reduced conventional annuity rates across the market.
He says: “We are looking at all options to increase the value of annuities we pay to our customers, and the increasingly attractive with-profits annuity is finding favour with both advisers and their customers.”
But Goodey warns while with-profit annuities are currently offering higher starting incomes they do not suit everyone as there is an inherent risk the income can fall as well as rise, so those who want a guaranteed income should still look into conventional annuities.
A with-profits annuity is linked to the returns on the investments in the insurer’s with-profits fund, and these returns are them paid to annuitants as bonuses each year, however these vary from year to year depending on the performance.
When taking out a with-profits annuity the client must also choose the level of ABR it excepts the fund to make, in the case of Prudential this can range from 0% to 5%. The level of ABR a client chooses then determines their bonuses, those who choose a high ABR will start off with a high level of starting income, but will see smaller yearly increases than those who choose a lower ABR.
Each year depending on the performance of the investments the insurer awards a bonus, if it is higher than the chosen ABR the clients income increases, if it is the same rate, the income stays the same and if it is lower the income falls.
However, within the product there is a minimum guaranteed level of income which the annuity will not fall below no matter what the bonus declarations may be, in Prudential’s case it is expressed as a percentage of the starting income and again this depends on the chosen ABR rate.
For those who choose a 0% ABR their annuity income will not fall lower than their original starting income, but if they choose a 5% ABR they are only guaranteed 55% of the initial annual outcome.
Kate Brownhill, product manager for retirement income at Prudential, says most people forget or underestimate just how long they are going to live, and are buying a secure income under a conventional annuity, without realising the potential effect inflation will have over the years, comparing it to working for 20 years without a pay rise.
But despite this, there is an inherent risk with the level of bonuses being awarded as, at the moment, in order to achieve an income which matches that from a level conventional annuity, a return of around 3% is needed, while the average choice of ABR for people choosing a Prudential with-profits annuity is 3.5%.
However in 2006, Prudential announced a regular bonus, one which is a permanent addition to the income and which cannot be removed, of 2.75% which is below the 3% return needed to match a level annuity.
According to their figures, Prudential last awarded a 3% bonus in 2003, with the last 5% bonus awarded in 2001, however it points out it also awards a second discretionary payment which can be removed at any time, called an “additional” bonus which applies for only the one year and which is based on how long the client has had the annuity. For this reason the awards for 2006 range from 8% to 51.75%.
But despite the possibility of a reduced income, Goodey says many pensioners are now realising “one way of avoiding the trap of low conventional rates is to purchase a with-profits annuity, which gives an income for life that can increase.”
Stuart Bayliss, managing director of IFA firm Annuity Direct, says while he doesn’t agree conventional annuity rates are falling quite as dramatically as Prudential say, instead suggesting they are staying relatively stable with top annuity rates increasing 0.13% since last year, he says with-profits annuities are good news.
He says while they may be relatively stable now, over the next 15 years at least, conventional annuity rates will decline because of trends in longevity and morbidity, and the only way to give them a fighting chance is to see a continuous increase in interest rates to balance the decline.
And while many people may argue there may be a correction to interest rates in the near future, Bayliss says nobody is expecting that to turn into a continuous increase, and at the best it would merely give annuities a stable rate for a while longer.
Instead, Bayliss says as long as people are not relying solely on this retirement income for day-to-day living it is a good idea to look at other options such as with-profit annuities, as long as they bear in mind income can go down as well as up.
But he says the popularity of with-profits annuities is not a sudden thing, instead he suggests it has been a continuous process, although he admits it slowed down around 2001 following Equitable Life’s failure, as people taking out with-profits annuities were put off by experiencing the bad years at the beginning of their retirement, and immediately losing some income.
Since then, he says more people are realising as we are living longer annuities are actually a good thing in guaranteeing an income for life, however they are also coming to the conclusion conventional annuity rates are not going to swing back up and are looking for alternatives.
But as interest rates have fallen, so has the level needed to make bonuses from with-profits annuities match level annuities, and Bayliss believes any recent drive in with-profits annuity business is because the numbers are much more stark.
He says: “People see they only need a 3.2% return to match a conventional annuity and they don’t think it is very much, they don’t realise there is a balance between the figures, and in the right market a matching return of 5% would be just as achievable.”
Bayliss points out: “I don’t think there has been any kind of enormous change, it just seems to be the starkness of the numbers is making advisers see the options more clearly.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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