Industry Voice: The lower risk conundrum - GRIPs vs annuity

Ryan Medlock, Senior Investment Development Manager at Royal London, considers the impact of recent market conditions on lower risk clients in drawdown vs those with annuities.

clock • 4 min read
Ryan Medlock, Royal London
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Ryan Medlock, Royal London

The current inflationary backdrop and market shocks such as the Autumn's ‘mini-Budget' led to a surge in gilt yields and detrimental impact on the performance of UK Government Bonds. This meant that investment solutions designed for lower risk clients were significantly hit over 2022 due to their higher allocation to fixed income strategies.

This is particularly the case for lower risk clients in drawdown, who may be wishing they opted for the certainty of an annuity instead. However, the picture might not look as bleak as the short-term performance numbers may appear.

Our Governed Retirement Income Portfolios (GRIPs) are designed for clients looking to take a sustainable level of income from their pension savings. With the focus turning to taking money out of a pension, there's a lower exposure to risk assets and higher allocation to fixed income strategies relative to solutions designed for accumulating, such as the Governed Portfolios.

Here we take a look at how the GRIPs have fared against annuities in recent years and consider whether clients who have invested in lower risk GRIPs are now in a stronger position to secure a better annuity rate.

The case for annuities

The introduction of pension freedoms and low interest rates in 2015 contributed to a decline in annuities. However, with gilt yields and inflation increasing over 2022, annuity rates are starting to look attractive once again as shown in the table below.

Source - Average annuity rates of 5 key providers. Rates shown are for a single life, level immediate annuity for a male aged 65 with a £35,000 pot.

The case for GRIPs

The GRIPs are designed for clients looking to take a sustainable level of income from their pension savings. The portfolios have been designed to be resilient and cope with challenging market conditions, while capturing market upside, and are well diversified across a mix of equities, high-yield bonds, corporate bonds, index-linked gilts, property and commodities.

Although the GRIPs continue to beat their respective benchmarks and deliver positive performance over the longer term, short-term performance, particularly in the lower risk GRIPs, has been more challenging due to the risk in gilt yields and impact on fixed income strategies. But despite this testing backdrop, could clients in our lowest risk portfolio, GRIP1, now be in a stronger position to annuitise relative to if they'd done so previously, due to the upturn in annuity rates? The case studies below brings this to life.  

Meet Mr Smith…

Mr Smith has a cautious attitude to risk. He turned age 65 in December 2018, and together with his adviser, investigated the income he could expect to achieve with his £100,000 pension savings. The choice was between a lifetime annuity which would have given Mr Smith certainty of income or investing in a low-risk flexible drawdown solution like GRIP1. Although both options are considered low risk, Mr Smith could have very different financial outcomes under each option in today's economic climate.

Example 1: Mr Smith buys an annuity

Based on his preference for certainty, Mr Smith's adviser recommends a lifetime annuity. As at December 2018, the annuity rate for a level single life immediate annuity was 5.2%, providing a lifetime income of £5,200 per year.

Example 2: Mr Smith chooses flexible drawdown and invests in GRIP1

Mr Smith chooses flexible drawdown so he can keep his money invested and aim to grow his pension savings. He transferred his £100,000 pension savings into GRIP1.

He's taken £5,200 income per year between 2019 to 2022, which is the comparable annuity income rate and is now left with pension savings of approximately £83,000.

Example 3: Mr Smith chooses flexible drawdown and invests in GRIP1 before buying an annuity

Mr Smith invests in GRIP1 and takes an income of £5,200 per year between 2019 to 2022. As per the example above, he now has a pension savings of £83,000. The chart below shows the fund value at the end of each period up to December 2022, assuming he takes a fixed income of £5,200 per year and the comparable annuity income that could be bought with the fund at each period.

Source: Royal London, January 2023

Over a four-year period, performance has been volatile and generally below the rate of income, resulting in a decreasing fund value. However, if we compare the level of income Mr Smith can buy with an annuity at the end of each period, he's now better off than he was in 2018 despite perceived poor investment returns driven by rising gilt yields. Mr Smith has also benefitted from an increasing annuity rate as he becomes older.

Past performance is not a guide to the future. Prices can fall as well as rise meaning your clients may not get back the value of their original investment. Investment returns may fluctuate and are not guaranteed.

Summary

This example highlights how the buying power of pension savings is more sensitive to changes in annuity rates than investment performance. Clients invested in lower risk investment strategies such as GRIP1, with the aim of generating a sustainable level of income to meet essential expenditure, can take comfort that they're in a stronger position relative to buying an annuity four years ago, despite significant short-term volatility. 

For more investment insights, visit Royal London's adviser website.

 

January 2023 / AL 5 ON 0115

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