Retirement Planning: why should you buy annuities?

Don't forget that an annuity bought at the right time, e.g. very late in life, can reduce the stress of having to think about one's income and having to keep finding the best places to invest money. It also means that you can give away more of your capital and thereby avoid/reduce IHT.

I have never understood how you could view an annuity as being low risk. It is a gamble on life, with the odds tipped in favour of the insurance company. So-called mortality drag is used to justify them, but is just a fudge factor invented by actuaries in my view. Personally I would never willingly buy one, because I prefer to remain in control of my capital, but obviously there are some situations where there is no alternative.

Depends on how you judge "risk", of course. If you judge risk in the classical financial sense then perhaps they are not low risk. But if you broaden your appreciation of risk and include aspects of behavioural finance and psychology then - late in life - they perhaps don't seem so "risky".

Ultimately, it's about serving a consumer need and that may not be "financially optimised" in the classical sense.

The aspect of risk that I don't see being covered and which I consider to be more of an issue than dieing "too soon" is the risk of payment default by the anuity provider. How is this risk judged and covered?

The concept of annuities is really best suited to people who have less personal discipline, i.e. "need protecting from themselves" compared to those of us who would plan carefully with a programme of straightforward drawdown from a SIPP, in the same way we acculated the wealth.

drt

In the experts comments there was no mention of Fixed Term annuities. As I am very close to retiring this seems a good bet where you still have some control of your capital and if you are one of the unlucky ones who pass away early at least the fund can go to the dependants.

Please correct me if I am wrong.

For me, drawdown has won hands down for the last few years. It has given me an income that has been satisfactory whilst leaving my investment amount fairly steady.

However, in the last budget the government has reduced the amount I can take from 120% of GAD to 100%. In addition to doing that they have increased the tax on death to 55%. This has effectively reduced my monthly income from drawdown by nearly a half!

At a time when the government is encouraging individuals to provide for their own retirement, this little publicised action hidden amongst the small print has been a huge blow to me and probably many others.

Changing to an annuity will leave me just as badly off whilst at the same time removing any opportunity to leave anything for my children after my demise.

There was absolutely no good reason for the change in the drawdown rules and to quote an old saying, "if it ain't broke, don't fix it"!

Edmond: You appear to be assuming that the retiree has continued good health and, in particular, good mental health. Unfortunately, there are an increasing number of people who are living well into old age but are finding it much more difficult to manage their own investment decisions - an annuity may have a role to play in guaranteeing some income and reducing the "stress" for the older person.

You could reduce your risk of capital loss by taking a joint life annuity.

Other comentators advocate - mistakenly - the alternative of gilts having less risk. This is not so. Although the yield may be good, bearing in mind the current environment of low savings rates, there will be a capital loss when your executors come to sell or redeem at maturity as EVERY gilt currently sells at a premium.

annuities should not be looked at as an investment as if that is the case then they offer a very poor rate of return they should instead be looked at as an insurance product and in which case they offer on average 0.85 of their value which is significantly better than equivalent insurance products such as car insurance (0.65).

Thomas: Exactly, they can provide "peace of mind" and therefore can have a role to play in certain circumstances. Thinking of them "only" as investments is like comparing apples with a root vegetable.

Equitable Life - I now wouldn't touch any insurance product and anything which says 'regulated by the FSA'. If you can, go for drawdown.

MP: annuities are covered by the Financial Services Compensation Scheme in the event of insolvency of the annuity provider.

The provision of a pension is a long term investment.

The usual advice for an investment of more than five or so years is to consider equity.

An advantage of drawdown is the opportunity to to mix and match, depending on personal circumstances.

For a difference of 1% who in their right mind would give up their capital. If this was a real option(other than 25% of the pension fund), you couldnt control demand. Is'nt that why most people take the full 25%!!

Thanks for the clarification Marketwatcher. Does anyone stress test the FSCS I wonder...

To all: I notice that a lot of comments are advocating "draw down". This assumes the annuity is a pension annuity rather than a purchased life annuity. The exam question set by Citywire relates to annuities in general. My earlier comments related to purchased life annuities bought late in life. No one else seems to be commenting on these. Why is that?

I have a SIPP in drawdown and a very helpful HMG have reduced the amount I can remove from it this year by a hefty 29% before tax. I now cannot live on the drawdown cash together with my State Pension as its all taxed.

The problem is that interest rates are now so low I have had to resort to investing in the stock market. This is just about the worst time I can think of to invest life savings - or any savings - in the stock market. There is just no way the West can survive its absurd borowing levels and a crash is inevitable at some point in the near future. The USA has a 14 trillion dollar deficit and this is on an exponentiating curve. Greece owes 30,000 Euros for every citizen. Crazy!

Pensions are a chimera and a very dangerous game is being played by the providers and the Government in encouraging older people to risk their remaining living standard in products that are engineered to benefit the provider. Annuities are apalling value for money. Its about time the whole pension pot was released to the owner to do with what he likes, not force him into actions that destroy his standard of living while he is fit.

This has everything to do with the amount of "risk" you are prepared to take. By "risk" here I mean the risk of your pension fund running out of money and throwing you on to the tender mercies of the state at 90.

The average man reaching 65 this year will probably (unless he lives in Glasgow!) live for another 24 years. Women, because of course they have a less stressful life - tongue firmly in cheek here - will have 26 years. That is a long time-frame. If you pay your pension fund to an annuity provider, you may get 6% a year, but that will not rise with inflation, and who knows what the financial health of the annuity provider will be in 20 years' time? (The Financial Services Compensation Scheme will only work for the first big annuity provider to fail). That looks risky to me.

On the other hand, I am pretty sure I can get my total portfolio (shares, ISA and SIPP) to increase by more than 6% a year. Say I can achieve 10% a year. I take out 6% as income, leaving 4% invested. The compound growth means that, far from running out, in 20 years' time my fund will have increased in value by 110%. That does not look risky to me.

Well said Dr Jimbo.

Why is a Conservitive-led government not freeing up individuals to enjoy the rewards of their pensions, they originally took initiative and risks to build?

When you purchase an annuity, you exchange capital for security. This is the raison d'etre of annuities, pure and simple. To all who are able to take on investment risk in retirement a myriad other options are open. To those who can't - very few, if any. Don't even mention "low risk investments" such as corporate bonds, PIBS, income finds, etc. that provide a "safe income" - there is no such thing outside an annuity.

Some advocate full control over capital and what marvelous returns they could generate by investing themselves; I suspect that many "canny" investors sold out in late 2008 or early 2009 at capital losses of more than 20%. Then they bought back in late 2009 or early 2010 when prices had gone up again. And that is how the majority of the investing population behaves - ordinary men and women are easily informed by their fear.

In this respect Governments need to encourage the provision of annuities in order to protect ordinary folks' capital from the frantic depletion that market cycles can entail.

Those worried about the loss of capital on annuity purchase can always buy a whole life insurance policy. When you compare the excess annuity income with, say, the current 15 year gilts yield, there is about 2.5% extra yield to fund such premiums. The policy with reproduce the "lost" annuity purchase capital upon their death as a tax free lump sum; compare this to drawdow capital taxed at 55%, or estate capital taxed IHT at 40%.

I have told my children not to trust any form of pension for the future, as this farce and rule change on draw-down taxation demonstrates how successive governments meddle with pensions rules and regulations all the time. Can't they simplify it and leave it alone permanently?

I recall saying to my accountant at the time of Gordon Brown's first budget, that it didn't seem as bad as I thought it would be! - He replied that he has just mugged all future private pensions and the beauty of it is that it will take ten years for the public to work out what he has done. Ten years later my fund is much less than I expected it to be, so I am drawing it down as fast as they will allow me as my faith in pensions legislation is now non existent.

When I was in my 20s, my accountant advised a private pension scheme to ensure regular saving.

At 65 I now need to take 25% of my pension pot of about £100K, so must decide between an annuity or a SIPP with drawdown. I'm a risk-taker by nature but with the western economies in such a debt-ridden state I'm concerned that the risk may be too high to opt for a SIPP.

One of the worst decisions I took was to invest in a SIPP, although I have successfully run our pension scheme for years.

Unfortunately, we now do not have full control over our own money and have to pay thousands out each year to "advisors" who do not advise - I take all investment decisions- and accountants. In other words, we are not trusted to look after our own money.

So I not only have to generate funds to pay my wife and myself a decent pension , but have to pay the hangers-on - by government decree.

We have taken out the maximum drawdown, pay out the maximum pension each year, charge a management fee which we also draw out and are gradually building up a private portfolio of high dividend-bearing shares, plus other investments.

Of course, when we kick the bucket the government will scoop up most of what is left of our pension funds. I hate the concept of "annuities," the idea that we are too stupid to manage our own money. How dare governments assume this!

If necessary we will even emigrate to avoid control of our funds. That's what I think of the absurd concept of "annuities." Fund managers? ha ha ha.....They manage very nicely. But only for themselves. Today all the investment information anyone needs is instantly available to those equipped with a brain. Do it yourself!

Alan Franklin - You must be in the wrong sort of SIPP. I am in a TD Waterhouse SIPP, and I make all the investment decisions, then go online and buy and sell the investments myself. I certainly do not pay out thousands a year to "advisors who do not advise" - then why are you doing it? I don't have an accountant - I fill in my own tax return. What is this "government decree" you mention? I'm a retired pensions lawyer, and I've never heard of it.

Equally, I have full control (Sippdeal, albeit with Barclays constantly trying to poach).

Went heavy into oil shares nearly a decade ago, despite warnings from 'professionals', such shares were dull and were only for trading, then watched them ten bag and more.

The means exist, to go your own way.

Its all very well to say that managing one's own SIPP is the best choice, but the actual process of buying and selling within it can be vey slow and the results unpredictable. Anyone who can obtain a 10% growth is doing better than every annuity provider!

I have a Standard Life SIPP, but when I place a sell or buy order I do not know what the price is! It can take 5 days to find out. In these troubled financial times this is not reasonable and is yet another reason why I feel that the ring fencing of pension savings through Government regulation within self-serving financial institutions is completely indefensible.

Annuities may provide a simpler alternative for some, but looking back 25 years - the predicted remaining lifespan for a 65 retiree - the cost of everything was far less. £100 worth of goods in 1985 would cost £230 in 2010. Its also worth remembering that between 1974 and 1981 there was only one year without double digit inflation - 1978 at 8.3% - with a peak of 24.2% in 1975. This could happen again. Annuities are not a guarantee of ongoing purchasing power and may instead lock one into a declining standard of living as inflation rears its head.

The crazy spiral of national debt and quantitative easing cannot continue for much longer. Today the UK Government announced it will take larger pension contributions from public sector employees. But this is just to service existing current account pension payments. It will not be invested in industry or elsewhere and ringfenced for the individuals involved. The whole system is flawed and we need to take a long hard look at what drives our domestic inflation and undermines savings.

You could be better off moving the SIPP to a better-established broker with a more transparent dealing platform, likewise I find Sippdeal (one of the originators hence why I am still with them) a bit behind the curve - but nothing like as bad as you imply with Standard Life. Share dealing blindfolded, doesn't inspire confidence!

The current climate of fear and uncertainty ought to be good for long-term equity investing, but as ever it is only possible to see a market turning point some months after the event.

I think the current outbreak of corporate takeovers suggests industry sees value in the stockmarket; naturally one needs to be selective but these ought to be good times for patient SIPP players.