At first sight, the latest data from the Financial Conduct Authority (FCA) suggests that the retirement annuity market is in freefall. Sales of annuities have fallen to their lowest level since the pensions freedom reforms of 2015 kicked in. But despite the headline figures, annuities may be about to stage a comeback.
It’s not difficult to understand why annuities have become unpopular. Annuities offer those converting their pension savings into income a guaranteed pay-out for life, which sounds very appealing.
However, the pay-out on offer has collapsed: 25 years ago, a £100,000 fund would have bought a 65-year-old an annual income of around £15,000; today it buys just £5,000. So with the pensions freedom reforms making it far easier to draw an income direct from your pension fund, rather than buy an annuity, many people have done just that.
Who’s buying annuities today?
Still, while sales of annuities over the six months to March 2017 were 16% lower than in the same period a year earlier, almost all of this reduction came from the number of people aged 55 to 64 buying annuities. Among older savers, annuity sales were stable or even a little higher. Similarly, while fewer people with smaller pension funds – those worth less than £30,000 – are buying annuities, sales are holding up among those with bigger funds.
These numbers suggest that older savers are more likely to appreciate the guaranteed nature of annuity income. They may be keen to investigate other options early in the years after they gain access to their savings, but as they get older, an annuity becomes more attractive. Similarly, while it’s understandable that savers with small pension funds may not be tempted by the tiny incomes on offer from annuitising their savings, those able to access higher pay-outs appear to feel differently.
Why demand is set to rise
There are two likely reasons why interest in annuities is slowly recovering. First, there’s the certainty offered by an annuity. Financial markets have performed strongly since the pensions reforms, so those who have left their funds invested have yet to suffer any serious setbacks, but there is growing anxiety about the effect that market volatility could have on pension-fund values.
Second, annuity rates may now stabilise or even improve. The rates of income on offer are closely linked to gilt (UK government bond) yields, which stand at record lows after a decade in which the Bank of England has kept interest rates at almost zero. With the Bank now openly discussing a return to – marginally – higher rates, annuity rates have begun to edge back upwards as well.
This isn’t to suggest that rates are about to surge – or that savers’ appetite for the products will ever see sales recover to the levels seen before pensions freedoms were introduced. But some savers are prepared to accept an opportunity cost in return for the guaranteed nature of an annuity income. And if annuity rates rise or financial markets fall, that cost – the value of investment returns forgone – may seem far smaller than it has in the recent past.
How to land the top annuity rates
Savers considering buying an annuity with their pension funds can maximise the rate they get with a few simple steps. First, always investigate the open market option. That means never take the annuity income on offer from your current pension-plan provider without checking what is available from rival providers. Rates vary enormously.
Second, be flexible about your requirements. By accepting less protection from inflation, or less generous dependants’ benefits, for example, you’ll get a higher upfront rate of income. Arrange your annuity according to your individual needs, rather than opting for the default settings offered.
Finally, look into whether you qualify for an enhanced annuity. These pay higher incomes to savers who providers think are statistically likely to live for a shorter period in retirement. The criteria are wide. Smokers qualify, as do people with serious illnesses, but you may also qualify if you live in a certain part of the country, or have done a particular job in the past.
Tax tip of the week
If you have to pay to repair or replace small tools that are necessary for you to do your job (such as scissors or an electric drill), or clean, repair or replace specialist work clothing (such as a uniform or safety boots), you may be able to claim tax relief on these expenses.
However, note that you can’t claim relief on the initial cost of buying these items (this might be covered by capital allowances instead). You can either claim for what you’ve spent, in which case you will need to keep all receipts, or claim a flat-rate deduction. Flat-rate deduction amounts are set by HMRC, and will vary depending on your profession. If your occupation isn’t on HMRC’s list, you may still be able to claim a standard annual amount of £60 in tax relief.
Pension transfer advice falling short
Fewer than half of the people transferring money out of final salary pension schemes are getting appropriate advice, according to the Financial Conduct Authority (FCA). Under laws introduced in the wake of the pension freedom reforms, savers transferring more than £30,000 out of defined benefit (DB) schemes to another type of arrangement are legally obliged to take independent financial advice. An estimated £50bn has been transferred out of DB schemes over the past two years.
However, an FCA sample of the advice given by 13 firms found that the recommendations given were suitable in just 47% of cases. In the remaining situations, recommendations were either unsuitable, or the firms lacked the necessary data to make a judgement. In both cases, this represents a breach of FCA rules.
Transfers out of DB schemes very rarely make sense. However, many savers have been tempted by the increased number of options they have on retirement in other pension plans, since pension freedoms largely exclude DB schemes. Interest has also been buoyed by many schemes offering savers very generous transfer values. Even taking these factors into account, however, savers need to think very carefully about giving up guaranteed income in favour of a pension that will depend on the performance of markets.