Alan Higham considers the potential alternatives to annuities in a retirement income strategy
The annuity is the default product of choice for 90% of people who are retiring. It provides a guaranteed income for life, which is a simple, reassuring concept for people as their income from work stops or reduces.
As chairman of Annuity Direct, you might be forgiven for thinking that I’m a huge fan too, but I also understand their limitations and when alternatives should be considered.
The first limitation of an annuity is whether it is good value for money. Effectively, you are handing over your pension savings in return for a fixed rate of return. What rate of return do you get? That depends on how long you live.
At age 65, you would need to live for 18 years to receive your money back. Today, you can save in a 12-month cash bond and earn 2%. If you lock it away for five years, you can earn 3% per annum. The latest ONS longevity studies show that life expectancy for a 65-year-old is just over 18 years, with considerable variations by postcode. Ten years ago, life expectancy was just under 16 years.
Today’s annuity rates assume people will live for much longer: 25 years for a 65-year-old. People who have chosen to save in a pension have historically lived longer, and statisticians have underestimated the ever-improving life expectancy.
If you lived for 25 years, then your annuity will have paid you a return of just under 3.5%, which is the risk-free return on over 15-year gilts. You would have to live well past 100 to obtain 5% per annum.
Investing in bonds
Investing in a diversified mix of equities and bonds ought to deliver more than 5% per annum over the term of the investment at retirement, so income drawdown is a reasonable alternative.
Partner Insight: For Blackfinch, the arrival of its IHT portfolio services was a 'natural evolution' in the group's offering and points to an established track record of returning cash to investors.
Senior Managers Regime
Interest rate outlook unchaged
FCA made demands last week