After many years in the doldrums suddenly retirement annuities are back in the news.  Why is this?

 

Well, the buying of a retirement annuity from a money purchase pension scheme (defined contribution scheme) used to be compulsory until George Osborne, the then Chancellor of the Exchequer, introduced so called Pension Freedoms as a parting shot when he resigned as Chancellor back in 2015.

 

Pensions Freedoms brought in some radical changes to these types of pensions including the abolition of the compulsory retirement annuity by age 75 at the latest.  Since then retirement annuities have been very unpopular with only about 10% of pension scheme members choosing an annuity purchase rather than the more popular option of Income Drawdown and some other less popular options.

 

 

 

The main  reasons why retirement annuities have been unpopular for so long are as follows;

 

  1. The annuity rates for over a decade were quite poor up until interest rates rose strongly over the last couple of years.  That’s because annuity rates are closely linked to interest rates.
  2. Most pension scheme members recognised that a retirement annuity offered poor value for money and were inflexible.
  3. Most financial advisers considered that Income Drawdown was more suitable for the majority of clients and it offered flexibility as well as a number of other benefits.

 

 

Now that the base rate has risen from 0.1% to 5.25% retirement annuity rates have returned to a more respectable level they are more worthy of consideration than they were for the 13 years of base rates of 0.5% or less between 2009-2022.

 

I expect the popularity of retirement annuities to increase in future years as long as interest rates don’t plummet again to a very low level.  However, barring changes in pensions legislation, I fully expect Income Drawdown to be the most popular retirement option for the foreseeable future.

 

There continue to be overriding reasons why Income Drawdown is far more suitable than annuity purchase when accessing your pension benefits.  Here are the main ones;

 

  • Most married people want to leave the maximum amount of money to their spouses on death.
  • Most parents and grand-parents want to leave the most money possible to their children and grand-children.
  • Most people prefer flexibility.
  • Retirement annuities generally only favour people who live a long time after buying an annuity, the so-called break-even point.
  • Gifting your pension to your heirs as Inherited Drawdown is free of Inheritance Tax.
  • If you die before age 75 your beneficiaries can take all of the benefits from their Inherited Drawdown free of all taxes.
  • Income Drawdown is not reduced on the first death of a married couple if the surviving spouse inherits the pension.  In other words, this is equivalent to a 100% widow/er’s pension.  A 100% widow/er’s retirement annuity is very expensive.
  • An Inherited Drawdown is likely to rise in value over the years even after accounting for income withdrawals which means the beneficiary can benefit from increasing income over the years without paying for an expensive index-linked annuity.
  • You can withdraw tax-free cash and income flexibly and piecemeal if you like.
  • You are able to vary your income for tax planning purposes.
  • A retirement annuity is totally inflexible.  For example, you cannot change your mind after you have bought one if, and when, your circumstances change, meaning you cannot convert it into Income Drawdown later.
  • A retirement annuity purchase is an irreversible financial planning decision which is the worst possible financial decision you could possibly take.

 

 

This last point is the key one here.  In my opinion, any irreversible decision in any aspect of your life is a bad decision.  Buying a retirement annuity and not being able to change your mind is the equivalent of jumping out of a plane at 10,000 feet without a parachute then wanting to change your mind.  It’s a disaster.  For most people buying a retirement annuity is just that.  A disaster.  Speak to any Equitable Life retirement annuitant and you will know what I mean.

 

Equitable Life was the doyen of the pensions industry until its spectacular collapse in 2000.  It didn’t technically go bust.  A lot of policyholders lost 50% of their life savings.  It closed to new business at the end of the year 2000.  It was taken over by Utmost Life And Pensions. Retirement annuitants who bought unit linked investment annuities were particularly badly affected.  It was an unmitigated disaster.

 

Ever since the Equitable Life debacle, I’ve never been a great advocate of retirement annuities apart from exceptional circumstances where they may be justified.  Here is a list of some reasons why you may consider buying such an annuity.

 

  • You have no life partner and you are unlikely to ever have one.
  • You have no close relatives and in particular no children or grand-children.
  • You have no close friends.
  • You have a very cautious attitude to investment risk.
  • You believe the annuity provider will not fail and reduce payouts.
  • You are not interested in saving Inheritance Tax.
  • Interest rates and consequently annuity rates rise to a very high level.
  • You qualify for an impaired life annuity due to your poor health.
  • You believe you will live a long life after retirement of at least 20 years.

 

So I do expect Income Drawdown to remain the most popular retirement benefits option for many years to come and it is likely to account for at least 80% of all retirement income choices. However, it is essential that you take professional financial advice from a retirement specialist because it is a complex area of advice.  You know it makes sense.*

 

 

*RISK WARNING

The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. The FCA does not regulate tax planning.  This blog is based on my own observations and opinions.  

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