Why buy annuity

dont_use_vistaprint

Hey, I’m trying to understand the benefits of buying an annuity and for what kinds of people / scenarios that is suitable for.

is this an effective way to maximise your investments income if your plan is to live a long healthy life and die with nothing? 

Do the numbers add up? Does it beat a drawdown plan ? 

Or is it more of an outdated survival methodology for when the state pension wasn’t enough to live on , and/or  people with no additional defined benefits pension? 

MK62

People buy annuities for several reasons, but perhaps the most common is for certainty of income......whether it maximises that income is unknown until many years have passed, so that's a judgement you have to make upfront (though maximising income isn't usually a reason for choosing an annuity). Same for "does if beat a drawdown plan" really - maybe, but based on historic data, probably not (but again, not usually the main driver for choosing an annuity).

As for being outdated, they fell out of favour for many years during the era of near zero interest rates, due to the poor payout percentage available......but that's changed somewhat over the last few years, and annuities are making a comeback again. 

As you've said, the downside is handing over a big pile of cash upfront and potentially dying with nothing.......but it doesn't have to be either that or drawdown - it's perfectly viable to use an annuity for part of your income, and drawdown for the other part.

arthur_fowler

I have just purchased a level annuity with the entirety of my DC pot. It will give the foundation of my income. I won't need to worry about investment performance for most of my pension. I will also get income from DB pensions as will Mrs F. My TFLS is now invested to provide tax free income as part of my plan.

I spent a long time weighing up annuity vs DD and for our circumstances it was the best option.

zagfles

People buy an annuity because they want a guaranteed income for the rest of their lives. Not to maximise lifetime income, definitely not to be the richest person in the graveyard. 

Buying an index linked annuity seems a lot more sensible than using drawdown at a so-called "safe withdrawal rate", which these days is generally less than an IL annuity would pay. You can get IL annuities at 65 for around 4.8% for single life and probably over 4% for joint. But it does seem some people seem to have a physiological aversion to handing over a massive amount of money and potentially getting only a small part back if they die young, even though, being dead, it's no use to them! 

I can't see the point of flat annuities. You just replace investment risk with inflation risk. Even IFAs don't seem to understand this when they waffle on about breakeven points based on guesses about inflation. The point of an annuity isn't to do what maximises lifetime income. Use drawdown for that. The point is to provide a guaranteed income for the rest of your life to pay bills, shopping etc, which will likely increase with inflation, which is unknown just like stockmarket returns. 

OldScientist

dont_use_vistaprint said:

Hey, I’m trying to understand the benefits of buying an annuity and for what kinds of people / scenarios that is suitable for.

is this an effective way to maximise your investments income if your plan is to live a long healthy life and die with nothing? 

Do the numbers add up? Does it beat a drawdown plan ? 

Or is it more of an outdated survival methodology for when the state pension wasn’t enough to live on , and/or  people with no additional defined benefits pension? 

An RPI annuity will give a guaranteed, inflation-proof income for life that is not dependent on market performance.

The annuity is ideal for providing essential income (however you want to define that) in excess of state pension and any DB pensions that you might need. Once that floor is established, then the risk portfolio (i.e., equities and bonds) can be used to provide a variable income that is highly unlikely to lead to premature portfolio exhaustion (unlike constant inflation adjusted withdrawals and the so-called 'safe' withdrawal rate) - a search for 'floor and upside' will find some info about that strategy. I note that for joint, 100% survivor benefit RPI annuities adding a 20 year guarantee (to provide a legacy income in the event of very early demise) does not affect the payout rate that much (a few 10s of basis points).

It is impossible to tell whether an annuity will beat a drawdown plan because the amount of income generated by a drawdown plan over 30-40 years (depending on age at retirement) is impossible to predict. Historically, retirees in the UK have been able to withdraw an inflation adjusted amount somewhere between 3.0% and 3.5% of their initial portfolio without running out of money before 30 years have elapsed - to reiterate, future 'safe' levels are unknown. These are worst cases, so in good retirements drawdown will tend to beat the annuity, but, IMV, income in good retirements can pretty well look after itself!

SmokeysTravels

The Lifetime pension annuity is the only option that guarantees to pay you for the rest of your life no matter how long that is. Nobody knows what advances in science might happen in the future to extend life. Of course the opposite is true and you could die soon after getting one. 

The most simple version is a single life annuity payable for the rest of your life. This will pay the most. The downside is if you die early you won’t have got back how much you put in and the annuity provider keeps the rest of the money. For this reason many people opt to add optional extras:
* guaranteed period - this could be up to 30 years - if you die before the end of the guaranteed period, the remaining period is paid to your beneficiaries.
*capital protection - can be full or partial - so if someone bought an annuity for £100000 and over the years received £60000 and then dies, if they had full capital protection, then £40000 is paid to their beneficiaries .
*joint life - you name a second annuitant when you buy the annuity- if you die and the second annuitant is still alive then your annuity is paid to them for the rest of their life at the rate you specified at outset (this could be 100%, 66%, 50% etc).
*escalating annuity- you choose at outset how much it will increase each year - this could be a fixed percentage (for example 5%) or linked to an indices such as RPI.

These options all will reduce the starting amount of annuity you will get paid compared to a single life level annuity. You can have a combination of these options. 

The other type of pension annuity is a fixed term annuity. This is where you have an annuity pay you an income for a fixed period of time (for example 5 years). At the end of that period if you have chosen a guaranteed maturity payment this is available to you and you have the option to buy another annuity, move it to drawdown or take as cash. You don’t have to have a guaranteed maturity payment and can use all your pot to provide the maximum income. Fixed term annuities might be useful to cover a period with a guaranteed income, such as the period between when you retire and your state pension kicks in.

A fixed term pension annuity will trigger the MPAA that reduces the amount you can pay into a DC pension to £10000 per year. A lifetime pension annuity does not trigger the MPAA.

In terms of death benefits, if you die and there is money to be paid ( as you have chosen joint life, capital protection or a guaranteed period) then it is paid income tax free if you die before age 75. If you die after 75 the beneficiaries pay income tax at their marginal rate. These payments are currently outside of your estate for IHT but the government has announced this will change in the future. 

If you are interested in getting quotes but don’t want to get hassled by providers or advisers, you can use the annuity comparison tool on the government’s Moneyhelper.org website. 

Annuities aren’t for everyone, but as has been suggested earlier might suit people wanting a secure income or as part of an overall retirement strategy.

dont_use_vistaprint

MK62 said:

People buy annuities for several reasons, but perhaps the most common is for certainty of income......whether it maximises that income is unknown until many years have passed, so that's a judgement you have to make upfront (though maximising income isn't usually a reason for choosing an annuity). Same for "does if beat a drawdown plan" really - maybe, but based on historic data, probably not (but again, not usually the main driver for choosing an annuity).

As for being outdated, they fell out of favour for many years during the era of near zero interest rates, due to the poor payout percentage available......but that's changed somewhat over the last few years, and annuities are making a comeback again. 

As you've said, the downside is handing over a big pile of cash upfront and potentially dying with nothing.......but it doesn't have to be either that or drawdown - it's perfectly viable to use an annuity for part of your income, and drawdown for the other part.

Thank you for this. That makes sense if you need certainty of income.. 

Dying with nothing is actually one of my goals and has been integral to my financial planning and deciding when I retired :-) I’ve never understood people who work far longer than necessary just to leave a ton of cash to the next generation. I’d much rather invest it in them while we are alive and let them make their own money when I’m dead.

So it’s Possibly one of, maybe the only , attractive thing about an annuity for me, And maybe as you suggest putting a small amount into one to top up my other pensions after age 65/67 might be a good idea as I plan to have  spent everything else by then

dont_use_vistaprint

zagfles said:

People buy an annuity because they want a guaranteed income for the rest of their lives. Not to maximise lifetime income, definitely not to be the richest person in the graveyard. 

Buying an index linked annuity seems a lot more sensible than using drawdown at a so-called "safe withdrawal rate", which these days is generally less than an IL annuity would pay. You can get IL annuities at 65 for around 4.8% for single life and probably over 4% for joint. But it does seem some people seem to have a physiological aversion to handing over a massive amount of money and potentially getting only a small part back if they die young, even though, being dead, it's no use to them! 

I can't see the point of flat annuities. You just replace investment risk with inflation risk. Even IFAs don't seem to understand this when they waffle on about breakeven points based on guesses about inflation. The point of an annuity isn't to do what maximises lifetime income. Use drawdown for that. The point is to provide a guaranteed income for the rest of your life to pay bills, shopping etc, which will likely increase with inflation, which is unknown just like stockmarket returns. 

Thank you I’m gonna check this as soon as they write to me which I understand will be six months before my 55th birthday, out but I am assuming the deals at my age (54) and my plan to live to 100 are not gonna be great.:-)

Cobbler_tone

Has to totally individual based on circumstances. For some it may be their only pension and they want certainty until they meet their makers.
For me it will be a basis of a modest DB pension and a flexi drawn down of a DC pot to smooth me to state pension age. I haven't even thought about the timings and order....i.e. bridging the DB, delaying the DC, or using the DC and delaying the DB etc. I think I might get an IFA as opposed to trying to crunch the various options myself.

arthur_fowler

zagfles said:

I can't see the point of flat annuities. You just replace investment risk with inflation risk. Even IFAs don't seem to understand this when they waffle on about breakeven points based on guesses about inflation. The point of an annuity isn't to do what maximises lifetime income. Use drawdown for that. The point is to provide a guaranteed income for the rest of your life to pay bills, shopping etc, which will likely increase with inflation, which is unknown just like stockmarket returns. 

Again, it depends......

For us a flat annuity I believe was the correct route to take. Rationale is:
1) We have various DB pensions plus full SPx2 that will kick in over the next 7 years (retiring at 60). These will mitigate (but not remove) inflation risk
2) We want a (relatively) higher income in the next ten years while we are hopefully fit and well enough to travel a lot (which is what we like to do).

dont_use_vistaprint

arthur_fowler said:

zagfles said:

I can't see the point of flat annuities. You just replace investment risk with inflation risk. Even IFAs don't seem to understand this when they waffle on about breakeven points based on guesses about inflation. The point of an annuity isn't to do what maximises lifetime income. Use drawdown for that. The point is to provide a guaranteed income for the rest of your life to pay bills, shopping etc, which will likely increase with inflation, which is unknown just like stockmarket returns. 

Again, it depends......

For us a flat annuity I believe was the correct route to take. Rationale is:
1) We have various DB pensions plus full SPx2 that will kick in over the next 7 years (retiring at 60). These will mitigate (but not remove) inflation risk
2) We want a (relatively) higher income in the next ten years while we are hopefully fit and well enough to travel a lot (which is what we like to do).

This is pretty much my plan to maximise activities and travel between 54 and 67, then live on SP and DBP