The pros and cons of purchasing an Annuity at retirement
Posted by siteadmin on Thursday 7th of February 2019.
Since Pension Freedoms were introduced in 2015, more of us are choosing to access our pensions flexibly when we reach retirement. With greater choice, the number of retirees opting to purchase an Annuity is falling, but is it still a route you should consider?
While an Annuity provides you with a guaranteed income throughout retirement, figures from the Financial Conduct Authority (FCA) show it’s an option that’s falling in popularity. Instead, retirees are increasingly favouring Flexi-Access Drawdown. This allows you to adjust the amount of income you receive while the remainder of your pension typically stays invested. According to the latest statistics:
- Annuity sales fell 14% in 2017 year-on-year; Drawdown sales increased 11% in the same period
- One in three consumers are using Drawdown in retirement, this compares to 10-15% opting for an Annuity
First, what exactly is an Annuity? It’s a product that you can purchase during your retirement. Traditionally, retirees would take the money saved within a pension and use this to buy a guaranteed income for the rest of their life. This income is often linked to inflation, maintaining spending power throughout retirement. It’s one way to create financial security once you’ve stopped working.
Why are Annuities falling out of fashion?
Retirement has changed considerably in recent years. As a result, some retirees are favouring flexibility over security.
Research from the Institute for Fiscal Studies suggests that retirees underestimating their longevity also plays a role in falling Annuity sales. Those in their 50s and 60s were found to substantially underestimate their chances of survival through their 70s and 80s. As a result, they placed less value on the security that an Annuity can deliver.
The findings also present concerns for those using Flexi-Access Drawdown. As retirees are responsible for setting the level of income they want to withdraw when using this way to access a pension, there is a risk they’ll run out of money if they live longer than expected.
The research states: “People who believe that an Annuity product offers them a low income may still choose to buy it if the insurance value it gives them is great enough. In other words, if someone is sufficiently worried about the chance of outliving their financial resources, they may choose to buy an Annuity even if they think that, on average, it will return them less than they paid for it.”
There are other reasons why retirees may choose to shun Annuities, including:
- The anticipation of large one-off purchases
- In order to pass wealth to children and grandchildren
- They already have a secure income for retirement
- They believe they can achieve a higher rate of return
If you’re approaching retirement, understanding the pros and cons of an Annuity can help you make the right decision for you.
The benefits of an Annuity
It provides a guaranteed income: If security is important to you, an opportunity to secure a guaranteed income is likely to be high on your list of reasons to purchase an Annuity. With this route, you don’t have to worry about your income in later years of retirement or what will happen if stock markets are volatile. It’s an option that can allow you to effectively budget each month without having concerns that your income will dip.
It can be linked to inflation: Inflation means the cost of living typically rises each year. If your retirement income is static, it means your spending power will slowly be eroded as time goes by. When purchasing an Annuity, you have the option to choose a product that will rise in line with inflation, preserving your ability to maintain the retirement lifestyle you want.
There is a range of options: An Annuity doesn’t just offer a single option, there are multiple products available. This allows you to choose one that’s right for you. A joint Annuity, for example, can be purchased by couples. If you’re worried about how your partner would cope financially when you pass away, for example, it can help to give you both peace of mind.
The drawbacks of an Annuity
Inflexible: Once you’ve purchased an Annuity, you can’t change your mind. You won’t be able to adjust your income, as you can in Flexi-Access Drawdown either. If flexibility throughout retirement is a priority and you don’t have other retirement provisions to use to achieve this, you may find an Annuity restrictive.
It may offer a lower level of income: Annuity providers offer various rates for calculating the income they’ll provide, so it’s important to shop around. Depending on investment performance and longevity, an Annuity may not offer the best deal when it comes to the total income it pays out.
Creating a retirement income that suits you
The most important thing to remember when planning your retirement finances is to create a plan that suits you. While an Annuity will be right for some retirees, particularly those that value certainty, it doesn’t mean it’s the best option for everyone. It’s also important to remember that you don’t necessarily have to choose between an Annuity, Flexi-Access Drawdown or another option. You can use your pension savings as you want, creating a hybrid approach if it’s more suitable for your lifestyle and priorities.
If you’re unsure which retirement income is best for you or want to explore the alternatives, financial planning can help. Please contact us for more information on your next steps.