Why an annuity could still be your best pension option

The death of annuities in April has been overstated. Even with the new freedom to access your pension pot, buying an annuity could still be the best form of retirement income, says High50’s Julian Knight

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close up of gold eggs in a nest.

As far as annuities are concerned, Mark Twain's famous quote that reports of his death have been greatly exaggerated comes to mind.

Yet sales of annuities have tanked ever since the Chancellor announced, nearly a year ago, that from this April pension savers were going to be able to bypass purchasing an annuity and access their retirement pot to spend or invest as they see fit.

Many people who have been approaching retirement have understandably chosen to wait and see; looking for more flesh on the bones from the Chancellor to see if the brave new world of free pension pots was what it was cracked up to be.

But now we know what was planned (the ups, such as greater freedom with your own cash, as well as the downs: a tax charge and the need to be cautious about blowing your hard-earned in one go) and it turns out, there is still a future for annuities.

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Why annuities fell from favour

Annuities have at best a mixed reputation. Sure they pay a guaranteed income for life, but they are inflexible and if you die soon after taking one out, are¬ poor value for money. In addition, falling interest rates and investment returns combined with increased longevity means that they have over the past decades offered lower and lower pay-outs.

What's more, this decline in the returns on annuities has been getting much quicker in recent years. It is a product that many presume has had its day.

Yet the coming of the new pension age, which effectively ends the compulsion to convert a pension pot into an annuity, leaving the saver free to withdraw their cash and invest and save as they wish, could actually lead to a cautious rebirth of the annuity product.

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What's good about an annuity

After all, annuities do a unique job: a guaranteed income for life at a time when you may be physically unable to work or frankly not want to could be invaluable.

In addition, a £100,000 pension pot, say (which is roughly three times the size of the average private pension pot in the UK) may seem like a lot of cash but can be burned through in a relatively short period if poor investments are made or no proper account taken of longevity - some seven years longer than most people estimate, according to pensions industry surveys.

Annuity rates continue to tumble

Who most needs an annuity

Many experts believe that for those with less than £100,000 in their pension pot (and, crucially, with few other assets to sell in retirement), shunning an annuity is dangerous play. An annuity gives you an income for life, and if you are in this category, this is not to be sniffed at.

Although annuities do have the reputation of being inflexible, in reality they can be tailored to the individual like no other financial product. Annuities can be bought which will pay an income to a spouse after your death for instance. Inflation – that scourge of all other investments – can be taken in your stride through an annuity, as there are products available that will pay an income which goes up in line with prices.

There are even annuities which are geared to those with potentially life-shortening medical conditions. If you have heart disease, for instance, you can expect that your annuity will pay 20, 30 or even 40 per cent more than if you didn't have the medical problem.

In the brutal number crunching word of the annuity market, the provider reckons that your life will be shorter than average, therefore they are comfortable paying you a higher income. If you outlive their assessment and continue to collect the higher income, you are winner in all ways.

Even less serious health conditions or being a smoker can lead to qualification for what is called an enhanced annuity, which means a higher annuity income.

Of course, the headlines and heady, expensive marketing ahead of this month's pensions freedom may have persuaded many to turn their backs on annuity. Annuity sales are believed to be only around half their traditional levels at present. But this may not be the best course for you or your family.

An income for life, however long you live

A spokesman for Just Retirement, which specialises in sourcing enhanced annuities for clients, says: "What is important is to get the best value from your pension. [Annuities] continue to be a good solution for those who want the certainty of a secure, guaranteed income for life, that they won't outlive. Because of this, they will continue to be the cornerstone of many people's retirement income."

Just Retirement, would say that, of course (they sell annuities for a living). But there are plenty of observers, particularly among independent financial advisers, who are expecting that after the initial excitement of pensions freedom (with many people – rightly – reviewing their options), they will see a steady flow of people choosing to go down the annuity route.

What's more, it is likely that annuity contracts will adapt in order to offer more flexibility to users, although this may well come at the cost of even lower returns. But the death of annuities, it seems is exaggerated; they still have a place in retirement planning, just not the exclusive place.

The new brave world of pensions freedom will increase the ways in which you can get value for your pension. It also increases the number of ways in which you can get poorer value for your pot, too. Either could happen through taking the money out of your current pension scheme and buying a property, managing your own investments on the stock market, or going the traditional route and buying an annuity.

One thing is for certain: best value for your pension is not to be found down at the Lamborghini showroom, as the pensions minister Steve Webb half-jokingly proposed, no matter how tempting that may be or how red the Lamborghini.

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