Henry Allingham –
Probably not a name you have heard of previously. Henry was a World War One veteran who lived to be 113. He owned an annuity.
Henry purchased his annuity (income for life) in 1962 and it paid out, year after year, until Henry passed away in 2010
– 48 years of income.
Annuities generally get a bad press, mostly based around the fact you lose control of a lump sum and if you die you lose the lot with nothing passing to your family.
They are the perceived bad points and whilst true in part do not tell the whole story.
The perception of losing control of a lump sum is not always true, especially if the annuity is purchased from a pension. Perhaps this is the fault of the pension providers who always give us an annual statement with a lump sum figure, yet we should understand from the day we start paying into a private pension it is only ever (under today’s rules) a quarter of the accrued amount that will be payable as a tax free lump sum. The remainder has to be paid as taxable income.
This blog post is not meant to be pro-annuity – As with all my work I remain neutral, preferring not to let personal perspectives get in the way of doing whatever is best and most suitable for any given client at any given time.
The aim of this article is just to point out a few positive aspects of annuities I have found in the course of my work, the first being for those that live longer, and we are told life expectancy is increasing all the time, an annuity can represent fantastic value for money.
Living too long or Running out of money
In many ways an annuity could be likened to buying insurance. One is insuring oneself against ‘living too long’, or to put it another way, running out of money.
When financial planning for clients, aiming to generate and provide income for life, one of the greater challenges I face on their behalf is to balance the risk and reward profile, keeping enough money in reserve to fall back on whilst investing in assets that will outpace inflation, thus retaining standard of living and purchasing power as time goes by.
An index linked annuity can address this, providing a definite source of income, for the remainder of life, increasing in line with inflation.
That said, annuity rates today are much lower than in the last 20 or 30 years or so, their rates being closely allied to interest rates and inflation. At the same time life expectancy has increased. In 1970 a man retiring at 65 could expect to receive a pension for 14 years. Today that is expected to be nearer 24 years of payment.
Without going into the maths and actuarial reasons (but for the more technically minded it is known, rather brutally, as ‘mortality drag’) there is a form of cross subsidy at work with annuities whereby, in simple terms, those that die soon after purchasing an annuity subsidise those that live a long time. The approximate cost of this for someone entering Pension Income Drawdown (see other blog posts for more info on this product) is around 0.5% at age 60 – a small price to pay? It rises to around 1% by age 70. However by age 85 the cost is around 5%. So the decade between age 70 and 80 is sometimes referred to as the ‘Annuity Age’ when it may well be sensible to convert pensions to annuities (but always take individual, professional, fee based advice on this)
Another positive for annuities is the simplicity they bring in financial planning, alongside the certainty. A regular, trackable, easy to understand level of income without any concerns over investment performance or otherwise to sustain that income.
But is there an optimum amount, what with the income being taxable? Arguably if you could keep your annuity income under the higher rate tax threshold and create other income that was non taxable elsewhere it may prove tax advantageous for you, especially if you received higher rate tax relief on the way in (in simple term, under current rules, tax relief of 40% on the way in, and only paying tax at 20% on the way out). Again, another area perhaps to take individual, professional, fee based advice on.
Another reason to not have ‘too much’ (crazy idea I know) in your pension when buying an annuity is a recent development by annuity providers based on demographics. Amazingly the size of the purchase price now goes against the policyholder! They now reason the size of the fund buying the annuity reflects social status, arguing a large purchase price means a wealthy client, and wealthy people live longer than poor ones.
The astute client will ensure their financial adviser knows this and will investigate whether to help them to purchase annuities in tranches to maximise income from various providers rather than use the full fund at once with one annuity company.
There are many factors to consider when purchasing an annuity.
My other blog post today consists of my helpsheet on this matter with areas and variables to consider before purchase.
Watch out when doing a ‘DIY’ job on annuity purchase. ‘best buy’ tables in newspapers and online are often manipulated to show best rates (ie for a man of
exactly 65) and if you do not fit the
exact criteria you’ll find yourself worse off. It is also unusual to find your pension provider is also the best annuity income provider so don’t just buy from them, especially if a bank product.
Shop around (see other blog post today).
Consider engaging a financial adviser with specialist annuity research software who can pinpoint the annuity provider who will give you the most money (known as exercising your ‘open market option’) for your unique, personal position. Make sure they charge a fee for this service so you can be sure they are not being swayed by a later commission on an annuity purchase. If you wish the adviser to subsequently help with the annuity purchase transaction and implementation, again look for a fee charging adviser so all your money is at work generating you income, not paying a commission.
In summary, conventional annuities are an excellent way of securing a fixed income for life, with or without things such as inflation linking or benefits for dependents. A series of annuities may work well too, especially for those leaving Income Drawdown pensions as time goes on.
Annuities are certainly not the right answer for all of the people, all of the time,
but they definitely are the right answer for some of the people, some of the time.
Ask yourself, when should you buy an annuity?
Just in case, like Henry Allington, you live to be 113 or older.
