Following the announcement of the “freedom and choice” that will be available to retirees after 6th April 2015, the sales of annuities have fallen by a third and those of drawdown have risen (1).
We consider the reasons for this and whether it is a trend that is likely to continue past April 2015.
Falling annuity rates
Much of the current disillusion with annuities is due to the fact that annuity rates have been declining fairly consistently since 1980 (2) however this should not outweigh the suitability of the contract for an individual with the specific objective of providing a known, and accepted, amount of income for the rest of their life. It does however provide a reason why it might be advisable for some individuals to delay purchase until they are older.
Annuity pricing is highly dependent on predicted life expectancy and one of the major reasons that rates have fallen so much is the fact that this has risen considerably. Logically, if an individual wants to get the same sort of deal that a 65 year-old was offered 30 years ago they should buy the annuity when their life expectancy is similar; in other words they have to wait until they are older. It is also possible that a better deal will be available at a later age due to health issues.
Dealing with change
Due to increases in longevity it will not be uncommon for people to spend up to 30 years in retirement. Given this fact it is hard to make a one-off decision that will be suitable for the rest of an individual’s life. Even with the new flexibilities which allow annuity income to change – the manner of the change will still have to be set when the policy is set up.
It is of course impossible to know exactly what will change during this period, but it is fairly certain that something will, and it is also possible to consider scenarios which appear to be likely for that client.
Flexible working
More and more people are retiring gradually, working shorter hours or fewer days in the week. For most people this will be a temporary situation and at some point working hours will probably cease altogether.
If income requirements remain broadly similar throughout this period then pension income is required to top up the reduced earnings during the period of part time work and then replace them altogether in the future. As the annuity market develops it may be possible to specify a step up in income at outset, but this still supposes that the client’s life changes exactly as planned.
A much better solution is to leave the client’s options open by phasing retirement, and still further income flexibility is possible if the crystallised money is phased into drawdown.
Changing income needs
Even after an individual fully retires their income needs are likely to change over time. Obviously the way in which this happens will vary considerably between individuals but a common pattern is the “m-shaped” (3) income where individuals increase their spending during the early part of retirement, reduce it during the middle as they become less active and then increase it again when health becomes an issue.
