Regulatory changes around pensions and inheritance tax could make annuities look even more attractive to retirees
I flipping love annuities. I’m still a couple of decades off retirement, but would buy one now if I could.
Isn’t it madness that running out of money is one of the most common retirement fears, but annuities – designed to alleviate that danger – are so unloved. Still only around one in 10 retirees opt for one over drawdown.
It’s not just the reassurance annuities offer that has appeal. In recent years rates have been heading upwards. Currently £100,000 would give you £7,821 a year for a single life annuity with no inflation protection, which is a pretty decent return. And then there’s the fact that they turn bad news into good. Global conflict and economic turmoil pushing up bond yields? Good for annuity rates. In poor health or suffering illness? Ditto.
But, on top of all that, I learned from annuity expert Billy Burrows this week that you don’t even have to use an annuity to provide an income if you don’t need one – you can use a fixed-term one as a cash investment. So, for example, a £100,000 investment could get you £126,369 back in five years – a return of 4.65 per cent. And the money goes straight back into your pension so gains are tax free. That’s a better rate than any cash Isa on the market. Sure, you might be able to beat that investing, but returns are not guaranteed and right now the stock market is a daunting place.
So why aren’t annuities more popular? The dilemma they present potential buyers with reminds me of a phone-in segment on the radio years ago. Someone calls in and is played the first few seconds of a song. The caller has to say if they want to pick that song to be played in full or roll again. They could pass multiple times, hoping that the next song would be better than the last, but at any point the game could end and if the caller hadn’t picked a song they would have to listen to whatever the last option was – however much a dud.
It was strangely gripping – there’s something riveting about hearing someone deal with the dilemma of locking into a decision or holding out for better, however low the stakes.
But with annuities, the stakes are enormous. Deals change daily, but buyers have to take their hard-earned savings and lock in to one irreversibly. Is any other financial decision so huge and irrevocable? What if you buy one and then rates soar? What if you buy one and then die the next day? The opportunities for regret are grotesque.
I chatted with a friend in the middle of taking an annuity out last year. She got fixated with checking rates – they’d go up or down and she’d wonder whether to lock in or hold out for better. Torturous.
So if savers struggle to get past this downside, despite the benefits that annuities offer, what will change attitudes?
Firstly, the industry is making progress on offering products that mitigate some of the risk. Those that guarantee a pay out to loved ones if you die within five years, for example.
There’s also plenty more work to be done
to understand the psychological barrier
to annuities.
If we were all retirement robots, annuities would be much more popular, but thankfully we’re human, emotional, weird and wonderful. That needs to be better understood
and explored.
But I wonder if the real driver of change will result from the one thing that savers loathe even more than the risk of regretting a poor deal: inheritance tax.
From April next year, any pension pots remaining when you die will be considered part of your estate for inheritance tax purposes. Overnight the balance will shift and the benefits of drawdown over annuities diminish.
Annuities offer two overlooked weapons against inheritance tax that will surely come into their own. Annuities can be a good way to turn capital into a regular income that can be gifted free of inheritance tax.
Even if you die within seven years of making the gift it won’t attract this tax, so long as this money comes from income, is made regularly and doesn’t impair your living standards.
Secondly, joint annuities can be used to leave an income to a loved one free of inheritance tax. Pensions can only be passed between spouses tax free, whereas a joint annuity allows you to leave an income to a partner to whom you are not married, or to a dependent.
I’m sure that we’ll see plenty more annuity fans in future as savers wake up to these benefits and the market innovates to make the most of them. And while innovating to make annuities more enticing, could someone please invent one that I could buy now as well?