Is there a future for the annuity market?

Guest blog by Malcolm Small, April 2016

Until the advent of pensions 'freedom and choice' last year, pretty well everybody (other than those in 'Defined Benefit' pensions) wound up securing a retirement income by buying something called an annuity with their pension fund at retirement.

Annuities are provided by insurance companies and guarantee to pay a certain level of income for life, no matter how long you live. For those in poor health or with adverse lifestyles, such as smokers, enhanced incomes can be provided. Typically, 60% to 70% of retirees can get an enhanced income this way.

The flip side of this is that, when you die, so does the remaining value of your fund, which goes to the insurance company and so, for those who die unexpectedly early, poor value can result.

The alternative, called “income drawdown”, draws an income directly from the pension fund, which remains invested under the control of the retiree and his or her advisers, if any. On death, remaining funds can be passed on, subject to tax in some cases. This route has soared in popularity since 'freedom and choice', despite the risk of exhausting the pot of money prematurely.

All this makes a recent research report from Legg Mason, the investment firm, rather curious reading.

According to their report, 72% of the over-40s do not intend to buy an annuity. Annuity sales have fallen from £2.5bn a quarter before 'freedom and choice' to just £990m a quarter now, it says.

But strangely, young people in their 20s appear to be enthusiastic about annuities. 84% report themselves “highly likely” to consider annuity purchase at retirement, with the more affluent even more likely to do so!

This is strange and does not correlate with consumer research I’ve conducted down the years. Whatever the industry may think, in my experience people love the idea of a guaranteed income for life, but hate the idea that “their” money goes to an insurance company when they die.

But those in their 20s, if the Legg Mason research is to believed, appear to be much more cautious than the baby boomers, apparently valuing the 'guarantee' of an annuity much more than the investment and other risks associated with 'drawdown' – despite the effective loss of control of the pension fund in the annuity route. If true, this will point to a revival in the use of annuities for retirement income in a few decades time.

However, I think the main issue is really generating adequate retirement funds in the first place. For many millennials, faced with the challenge of finding work, paying off the student loan, buying a car, paying rent and saving the deposit for house purchase, a worthwhile pension fund will be something they can only dream of.

For them, how they draw down an income from that fund seems a distant consideration. Automatic enrolment into a pension saving policy will help, but current contribution levels are inadequate and need raising over coming years if anything like adequate retirement funds are to be created. Only then will today's young people enjoy the luxury of choosing how to take an income!

Malcolm Small is Chairman of the Retirement Income Alliance ( Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Malcom's views are his own and do not constitute financial advice. 
Published on 27/04/2016