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Will 2018 be the year of the annuity after all?

Will 2018 be the year of the annuity after all?

At the beginning of last year I asked the question; “Was 2017 going to be the year of annuity after several years of decline in rates and popularity”. In early January 2018 I reported “annuities are still in the doldrums and there are few signs that things will improve significantly in the next few months”.

However by the 2nd week in February I am telling a different story because annuity rates are on the up. What a difference a few weeks makes!

The chart below tells the story

Yields started to rise in mid-January and by 12th February the benchmark gilt yield has risen to 1.91%, up from 1.67% on 1st January. As a result all of the annuity providers have increased their rates by a small margin. Don’t get too excited because someone purchasing a £ 100,000 annuity will only get an extra £ 100 per annum.

   

Annuity changes, week by week



I hope to be able to report later in the year that the upward momentum has continued, and the tide has turned for annuities but several things need to happen.

Bond yields

First, bond yields need to keep increasing. Throughout 2017, the 15-year benchmark gilt yield remained below 2%. Yields have been low since the credit crunch in 2007. Before then yields were over 5% and the benchmark annuity (£100,000, joint life 2/3ds for ages 65 and 60 and with level payments) was paying about £6,500 per annum compared to about £ 4,500 today. That is £ 2,000 a year or 30% less than an annuity today. This tallies with the rule thumb of that 100 basis points fall in yields results in 10% fall in annuity rates.

It is unrealistic to expect a return to pre-credit crunch yields but yields may move above 2% level soon. If yields rose to the 3% level and annuity incomes increased by 10% I think annuities would start to compare more favourable with drawdown.

Stock market volatility is the enemy of drawdown

If annuities are to become more popular, drawdown will have to be less popular. Annuities do not fall in a vacuum and at the heart of the annuity / drawdown comparison is the relationship between bond yields and equity prices. The stock market has been buoyant over the last few years and therefore drawdowns funds have increased in value, but as the recent in equity prices has shown we may be in for a period of uncertainty and volatility. This may prompt some drawdown investors to review their risk profiles and perhaps look for some income guarantees.

The advantages of annuitisation

Before annuities become more popular again, advisers and their clients will need to be convinced of the advantages of annuitisation. This is no easy task because since pension freedoms the reputation of annuities has been trashed. In all fairness, the reputation of annuities had been under attack for many years before that, but it was pension freedoms that provided the final nail.

One of the problems with annuities is there is lot of misinformation and biased criticism. Annuities are still the only policy that can guarantee income for life with no investment risk. The problem with annuities is not the annuity concept itself, i.e. mortality cross subsidy, but the low rates of interest. However, it is important to remember that the benefit from mortality cross subsidy is relatively small at younger retirement ages which means that annuities are better suited to older people.

Conclusion

I think the case will annuities will grow stronger over time as long-term interest rates increase, the risk of investing in equities becomes more apparent and retirees realise that guaranteed income is important.

 

About the author

Billy Burrows

Billy Burrows has been involved with retirement options for over 20 years, advising clients on all aspects of pensions and retirement income options.

He divides his time between advising individual clients as Retirement Director at Better Retirement and running Retirement IQ, which publishes guides including the popular ‘You and Your Pension Pot’ and ‘The Retirement Journey’.

He is frequently quoted in the national press and appears on radio, podcasts and videos and writes extensively on retirement income matters.

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