Pros and cons of buying an annuity

Yukster

As I plan for retirement in the next few years, I want to find out more about the pros and cons of buying an annuity for when I start withdrawing my pension from my SIPP. My plan is to continue working part-time into my retirement and i have other sources of income so I won't completely rely on my pension for income 

If I understand this properly, buying an annuity gives me more certainty about how much pension income I will have. The alternative approach is not to buy an annuity and instead draw as much income as I need when I need it. What are the pros and cons of each approach?

arnoldy

Yukster said:

If I understand this properly, buying an annuity gives me more certainty about how much pension income I will have. 

Yes, but that's no use if you are exposed to inflation where you have zero certainty!!. For example this year all people on fixed annuities are likely to be 10% less well off for the rest of their lives with more poverty to come depending of what inflation is for the rest of their lives.

The alternative is to buy an inflation proof annuity, but that is massively expensive and your surviving partner gets 50% at  most usually. To provide a £2k a month, an inflation proof annuity with 50% partner benefits, would cost you £1m +

Oh, and by the way that £1m is gone when you both go.

Very hard to see any pros - in my opinion, possibly apart from a "charitable" donation to the financial services industry.
  

westv

arnoldy said:

Oh, and by the way that £1m is gone when you both go.


  

That's only a downside if you have someone you want to leave it to.

Albermarle

Although the original question on this thread was about tax on annuities it developed into a wider discussion .

Annuities — MoneySavingExpert Forum

To provide a £2k a month, an inflation proof annuity with 50% partner benefits, would cost you £1m +

One key point in the above thread is that the cost of annuities is starting to come down , plus of course you can have an annuity for part of the pension and drawdown for the other part.

Secret2ndAccount

If you expect to have enough coming in to pay the bills and put food on the table, then I would not be buying an annuity at this time.
The beauty (the ONLY beauty, but its a big one) of an annuity is the guaranteed knowledge that a cheque drops on to the doormat every single month for as long as you live. The price of this certainty is that the provider can only invest in low risk investments, so they don't make a lot of gains on your money. Therefore you don't get a lot out in comparison to what you put in. See the comments above. Where an annuity becomes more attractive is as you get older. Since you might have only a few years left, the provider can give you a bigger monthly payout. If you happen to be the one who lives to a ripe old age, you will be very glad of that annuity. You collect a lot of extra monthly payments, paid for by the less fortunate who died a lot younger. This is called 'pooled mortality risk'. They can pay you a rate based on an average lifetime If you hang on to your own SIPP, you can't spend it based on an average lifetime - you have to hold some back in case you live longer.

So at age 65, an annuity is relatively costly, and only a good choice for those who want nothing at all to do with managing their money. Ever. When you are 75, this option might look much more attractive.
Also, my expectation (and I don't think I'm the only one) is that the annuity payouts offered will increase over the next year. So now is not the time to be buying an annuity at any age.

There are several common types of annuity:
Level - the monthly payment is fixed, so it loses constantly against inflation. This is cheaper to buy, but is it useful in the long term with no inflation protection?
RPI linked - this keeps up with inflation, but it costs a lot to buy.
3% rising - provides some inflation protection, and doesn't cost so much.
With or without spouse's pension - costs more, but pays 50% to your other half after you are gone.
You can get better rates if you can persuade them that you have a below average life expectancy.

Here's a table of the payouts on a 100k purchase. Note this is ANNUAL. In other words, your monthly payout is going to be in the ballpark of £200-£500 for 100k put in.

Albermarle

Just a couple of things maybe missing from the above detailed post .

It is possible to buy a fixed term annuity , rather than a lifetime one . 
This could be useful if you had a few years gap between retiring and state pension and were not confident in using drawdown.
The rates would clearly be better than above .

There are even fixed term annuities that pay some of your money back at the end .

Malthusian

arnoldy said:

Yukster said:

If I understand this properly, buying an annuity gives me more certainty about how much pension income I will have. 

Yes, but that's no use if you are exposed to inflation where you have zero certainty!!. For example this year all people on fixed annuities are likely to be 10% less well off for the rest of their lives with more poverty to come depending of what inflation is for the rest of their lives.

A slight exaggeration as while their fixed annuities are worth 10% less, their State Pensions are linked to inflation. So they are worse off by 10% times whatever percentage of their total income is the level annuity.

The more well off someone is, the less likely they are to buy an annuity, so it would be an unusual for someone's level annuity to dwarf their State Pension(s).

The alternative is to buy an inflation proof annuity, but that is massively expensive and your surviving partner gets 50% at  most usually.

Annuities can be 100% joint life if the buyer wants.

westv

Malthusian said:

arnoldy said:

Yukster said:

If I understand this properly, buying an annuity gives me more certainty about how much pension income I will have. 

Yes, but that's no use if you are exposed to inflation where you have zero certainty!!. For example this year all people on fixed annuities are likely to be 10% less well off for the rest of their lives with more poverty to come depending of what inflation is for the rest of their lives.

A slight exaggeration as while their fixed annuities are worth 10% less, their State Pensions are linked to inflation. So they are worse off by 10% times whatever percentage of their total income is the level annuity.

The more well off someone is, the less likely they are to buy an annuity, so it would be an unusual for someone's level annuity to dwarf their State Pension(s).

And RPI linked annuities can be 50% less than level annuities in the first year.

Thrugelmir

With an annuity you are pooling the risk with others. Guaranteeing an income for your entire life. You won't be exposed to the volatility of the stock markets nor have the concerns of either managing your portfolio or paying someone else to perform this for you. 

Annuities come in many forms with many options. Certainly worth exploring. As there's no requirement to buy just one. 

Thrugelmir

westv said:

Malthusian said:

arnoldy said:

Yukster said:

If I understand this properly, buying an annuity gives me more certainty about how much pension income I will have. 

Yes, but that's no use if you are exposed to inflation where you have zero certainty!!. For example this year all people on fixed annuities are likely to be 10% less well off for the rest of their lives with more poverty to come depending of what inflation is for the rest of their lives.

A slight exaggeration as while their fixed annuities are worth 10% less, their State Pensions are linked to inflation. So they are worse off by 10% times whatever percentage of their total income is the level annuity.

The more well off someone is, the less likely they are to buy an annuity, so it would be an unusual for someone's level annuity to dwarf their State Pension(s).

And RPI linked annuities can be 50% less than level annuities in the first year.

The rapid rise now of inflation is going to reap dividends for those who opted for this type of annuity in the past. Annuities are a form of insurance. Something I'd never say about equities. 

westv

Thrugelmir said:

westv said:

Malthusian said:

arnoldy said:

Yukster said:

If I understand this properly, buying an annuity gives me more certainty about how much pension income I will have. 

Yes, but that's no use if you are exposed to inflation where you have zero certainty!!. For example this year all people on fixed annuities are likely to be 10% less well off for the rest of their lives with more poverty to come depending of what inflation is for the rest of their lives.

A slight exaggeration as while their fixed annuities are worth 10% less, their State Pensions are linked to inflation. So they are worse off by 10% times whatever percentage of their total income is the level annuity.

The more well off someone is, the less likely they are to buy an annuity, so it would be an unusual for someone's level annuity to dwarf their State Pension(s).

And RPI linked annuities can be 50% less than level annuities in the first year.

The rapid rise now of inflation is going to reap dividends for those who opted for this type of annuity in the past. Annuities are a form of insurance. 

Depends how long ago and where inflation goes in the future.