Annuities - value or scam?
by Doug Brodie
In this blog:
It’s all in the maths
Colin the Client
/1 It’s all in the maths
The marketing departments of the annuity companies have been kickstarted by the Kwarteng/Truss events, and we always take into account annuities when organising and advising on income solutions for our clients.
I wonder if you’ve ever wondered how we came to have so many large insurers in the UK, financial leviathans of global repute. In the years that we grew up we had household names like The Prudential, Norwich Union, Commercial Union, General Accident, Scottish Widows/ Life/ Amicable/ Equitable and Mutual, Equitable Life, Standard Life, Royal London, NPI, Provident Mutual – phew, there’s a long list.
When pensions came in to being they were effectively a promise of income in retirement, there was only a final salary version, and that meant that no capital ever left the provider of the pension.
Annuities are the same (though yes, I exclude the rare beast that is the Purchased Life Annuity). A major contributor to the growth and financial foundations of our life insurers has been annuity business because the entire capital value of the diligently acquired pension savings was, by law, acquired by the annuity provider in return for an income for life.
With annuities you have a 100% capital loss on day one. Before ‘pensions freedoms’ came in in 2015, all personal / money purchase pensions had to be surrendered for an annuity from one of the providers by your age 75. The 2015 Act changed the law, allowing you / everyone to keep the capital value of your pension till death, and to leave that pension to any beneficiary you choose – your spouse, kids, grandchildren (uni fees?), a favourite charity or even your next-door neighbour. Wouldn’t you rather leave that pot to someone you choose instead of gifting it to the shareholders of Legal & General, Aviva, Standard Life et al.?
/2 Colin the Client
Forget what you read in the papers because they are cherry picking; I have been prompted to write this article as we were asked by a client – I’ll call him Colin – to look at using half his pension to buy an annuity.
Now as a married man he has responsibilities for his wife, and he has kids as well, probably some grandchildren in future years. The variables in buying an annuity are:
the % to leave to the spouse on death;
the annual increases in payment; and
if you want the payments to be guaranteed for a minimum number of years.
That last item is in case you drop dead the day after you buy the annuity:
Colin the Client is married, he’s 59 and his wife is 57. The figures below show what £500,000 from his SIPP would purchase by way of income – guaranteed income, mind you – from Canada Life, who were the only company to quote. (Others want lower sums or lower amounts paid to the spouse).
Colin is not on his uppers, and has sufficient cash for a competent, solvent retirement. Being 59 he knows that inflation can be dangerous so he’s either looking at providing his wife with 100% of the income when he dies, or 50% (other amounts are available, but these illustrate the point).
He’ll take the RPI linking – it’s a dangerous false economy not to have a rising income for the next 30-odd years.
If he’s only leaving his wife 50%, for his £1/2m spend, at today’s annuity rates, he gets £15,977 pa, and if he leaves her 100% he gets £14,368, which is £134 per month less. Not a big difference. That’s 3.2% return on his £1/2m spend, or 2.87%.
If he takes the 3.2% he will have to live till he is over 90 just to get his capital back and be in profit.
If he chooses the 100% bequest to his wife he’ll have to live to almost 94.
Aviva tells us that his actual life expectancy is to age 86, so the Canada Life actuaries are betting they won’t have to pay him back his investment, never mind any growth.
If Colin kept the £500,000 in cash at 0% interest and simply paid a flat £27,525 to himself, that would last till he’s 77, so he runs out of money if he’s still alive. That £27k figure is the annuity in the table above is the amount an annuity would guarantee today with NO increase, but leaving 100% income to his wife when he dies.
As it happens, Colin’s trust portfolio income will generate £25,470 this year – that income is not guaranteed however he has a 4.68% yield to his cost, growing by 3.5% per year, meaning his projected income on the £500k in five years’ time will be over £30,000, and by the time he is 86, and due to die according to Aviva, his £1/2m will be producing £64,500 to leave to his wife, plus the capital value (at 2% annual growth) will be around £1.1m to leave to his [fill in the gap with your beneficiary].
The actual statistics of the annuity market were missed off by the Sunday Times, and they do happen to be published by the ABI; in q1 of this year sales of annuities were up 22%, the median pension pot used was £46,000. Annuity guaranteed income is great for those who absolutely need the guarantee, who need that safety net.
For Colin? Not so much ….