In the past, many advisers and their clients thought of an annuity purchase as a black or white decision; smaller funds purchased an annuity and the larger funds invested in drawdown. This rather simplistic approach to retirement income planning should be replaced by a more sophisticated approach to annuities based on customer needs and wants.
Generally speaking there are three important things everybody should consider when they reach retirement age:
• How much income is required now and in the future?
• How much flexibility will be needed?
• How much risk should sensibly be taken?
Most people need income, but while it is tempting to have the pension pot paid as a cash sum, this may not be the best answer for those who do not have a genuine need for cash – for example, to pay off debt or to fund a luxury such as a new car or a world cruise. Not only is there a risk of paying too much tax, but taking a pension in cash means giving up the option to have a regular income each month.
Flexibility and certainty are opposite sides of the coin. For most people, flexibility is desirable but certainty is more important. There are very good reasons why people may want flexibility – income needs may change, circumstances can alter and health may deteriorate. But this flexibility comes with the price of less certainty.
One of the best ways to maintain flexibility while having an income is to invest in a drawdown plan. However as this strategy may be too risky for many, it may make sense to split a pension pot between annuities and drawdown in order to have some flexibility and some certainty.
As neither annuities nor drawdown on their own deals with all these risks, a good way to reduce risk in retirement is to invest in a combination of annuities and drawdown.
In conclusion, annuities will have an important role to play in the future. Although sales of annuities may be lower, especially for younger pensioners in good health, they will be used in a more sophisticated way. For instance, people are being advised to secure the amount of retirement income they need for their basic everyday needs through the purchase of a guaranteed annuity, and in order to avoid the negative effects of mortality drag, it often makes sense to purchase annuities at regular intervals in older age. Also, the benefits of enhanced annuities must not be overlooked because they are still one of the best ways for those in poor health to boost their income.
