Killik’s William Stevens asks savers to look beyond the attractive rates offered by annuities.
Savers enticed by the current high incomes offered by annuities should take a moment to reflect on whether this is truly the most suitable option for their long-term retirement, according to Killik’s William Stevens.
Annuities, or retirement products that take pension savings and provide a guaranteed income in return, were relatively unattractive when interest rates sat at record lows but have started to gain more attention after the Bank of England hiked the base rate.
Stevens, head of financial planning at Killik & Co, said: “Interest rates have a direct impact on annuity rates – when interest rates are high, annuity rates tend to be higher as well.
“Due to the current high interest rates in the UK, many providers are happy to advertise headline rates of 5% or 6%, which has made many view annuities as an incredibly favourable option for retirement.”
However, he urged savers to look into the products in more detail before relying on them to fund retirement.
The amount of income received – known as the annuity rate – depends on a variety of different factors such as the sum deposited and the individual’s health. “It’s important to assess how your individual situation will affect your annuity rate before you commit to purchasing one,” he said.
What’s more, there are two key elements to focus on which could affect the chances to receiving the advertised annuity rate: inflation protection and death benefits.
Inflation protection involves ‘index-linking’ the annuity so the income received increases with inflation (or by a fixed rate) each year, thereby maintaining purchasing power. This is optional, but would ensure the retiree avoids dealing with diminishing spending power.
Death benefits, on the other hand, involve the capital. Annuities involve exchanging the value of a pension for a guaranteed income, which means the capital element of the pension is lost on purchase and cannot be inherited unless the purchaser has opted for ‘spousal benefit’.
“Opting for things like a form of inflation linking or spousal benefit for your partner affects the rate you will get on your annuity,” Stevens explained. “So, while many providers seem to offer generous annuity rates of 5% or 6%, by the time all other elements are considered, real rates often tend to be more around 3% or 3.5%.”
When this is taken into consideration, then other drawdown options such as a personal pension or SIPP might become more attractive than an annuity.
Stevens pointed out that a personal pension or SIPP automatically has an immediate death benefit, thanks to the fact they can be passed onto a spouse or any other beneficiary without incurring inheritance tax.
Meanwhile, investing a pension into assets such as equities, bonds or alternatives can build in a degree of inflation protection.
Pensions also offer greater flexibility, allowing retirees to adjust their drawdown amount to meet current expenses or allocate funds for emergencies.
Finally, they can be blended with ISA income to bring down the marginal rate of income tax.
Stevens finished: “Annuities can offer a secure income for life; however, this comes at a cost. It is important to consider whether the income you are receiving is going to be sufficient in the later years, where it may be eroded by inflation, when you may need it most to fund expensive care fees. In addition, the loss of any heritable asset means, that for those who can afford to leave a legacy to their children, you may be giving up a very efficient vehicle from an Inheritance tax perspective.
“Of course, each person’s individual situation is different, and there is no one-size-fits-all approach to funding your retirement. Many retirement income options can be used alongside one another, which further adds to the complexity. Talking through your unique situation with an expert to receive bespoke advice and a plan that benefits you the most is crucial when it comes to making these decisions.”
