Vince Smith-Hughes talks to Retirement Planner about income choice annuities
What are the key benefits of income choice annuities?
A higher level of starting income than under a conventional annuity; the potential for income to grow; the ability to change that level of income; and having a guaranteed underpin, so that income will not fall below a certain level.
It suits a fairly wide range of people - from those clients who have pension pots of around £10,000 and have got other sources of income to those with much larger pots.
At the lower end, it is for people who can afford to take an element of investment risk, on the basis they will hopefully get a better return and a hedge against inflation.
At the larger fund end, it is for people who are thinking about drawdown but who perhaps want potentially higher and more sustainable levels of income than drawdown provides, while still enjoying some investment element. It is also not just a case of saying we are going to buy this product in isolation. I know several IFAs who sell these in conjunction with conventional annuities, selling two products to give clients a different solution.
When you buy a conventional level annuity, you do so knowing you have got a guaranteed stream of income from day one which will never go down.
If you buy an income choice annuity for, say, half the pot, you have also got the potential for upside of income as well. You are giving a high guarantee, but with the potential for growth.
What are the issues advisers need to take into account when considering this type of product for clients?
They need to explain to clients about the downsides as well as the upsides. I always make it clear when I am speaking to people that there is an element of investment risk. Clients need to understand that. And to make the question slightly wider, I think it is important for advisers to talk about all of the potential at-retirement risks. For example, a lot of people are going into level annuities with absolutely no protection against inflation.
Advisers need to look at inflation risk and the risk to any dependants if clients do not make provision for them. They also need to talk about the guarantee on these arrangements.
What role can income choice annuities play in this volatile market?
People are reaching retirement and their funds may have suffered due to the falls in the market. If you buy a conventional annuity, you have crystallised your losses. If you buy an investment-based product, it allows you a chance to recover as the market potentially comes back. If you compared income choice with income drawdown, the rate of return required on income choice is significantly less than on income drawdown. The return is not just made up of investment return - you are in a mortality pool, so this forms a large part of the return. You might find for example, depending on age, you may need one and a half or two percentage points less growth in income choice, than you need in drawdown to maintain the same level of income. That is quite a substantial difference and suits the sort of people who are more interested in income. That is not to say that drawdown doesn't have its advantages - it certainly does in terms of flexibility. It's a case of horses for courses.
While current inflation is 5%, surveys from Age UK suggest many pensioners face something like three percentage points over that figure - and are seeing inflation relative to them of 8% or 9%.
So, the need to have growing income is important, as you might have the situation within a relatively short period of time where if a level income is selected, it is eroded by inflation relatively early.
Also, flexible retirement solutions are coming into their own. A lot of people are retiring fit and healthy in their 60s and may have ten years or more where they want to do lots of things, and take more income. These solutions offer people the chance to do that. With annuity rates as low as they are, it is a good time for advisers to look at alternative solutions.
Vince Smith-Hughes is head of business development at Prudential
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