Lifetime Annuities have been subject to much speculation about their future recently. It is true to say they have received a negative press for some years, mainly because of falling rates and their inflexibility. However, for many they still offer extremely attractive levels of guaranteed income when compared to other options.
The question always remains however, if a Lifetime Annuity is right for me, when should I buy one?
If you wanted to delay the purchase of a Lifetime Annuity the choice has historically been stark with Income Drawdown and its associated complexity, charges and risks, being the only real alternative.
The advent of the Fixed Term Annuity means this is no longer the case.
A Fixed Term Annuity allows you to purchase an Annuity that will last for a pre-determined period of time, income will be paid to you (although it can be used in a version where income payments are not paid out and are ‘rolled up’). After the end of the term you have the full range of options
available to you, in that you can purchase a further Fixed Term Annuity, move into Income Drawdown or indeed purchase a Lifetime Annuity.
So, if a Lifetime Annuity is right for you, why delay and why purchased a Fixed Term Annuity?
According to Living Time, a provider of Annuity products, as many as 50% of all Annuity applicants could benefit from impaired rates at age 75. The uplift from an Enhanced Annuity can be as much as 70% at age 75.
A Fixed Term Annuity could be used to delay the date at which a Lifetime Annuity is purchased, to a time when health is worse and therefore an Enhanced Annuity can be obtained. If a Lifetime Annuity is purchased when an individual is healthy, no change to an Enhanced Annuity can be made should the applicant’s health worsen overtime.
Buying a Lifetime Annuity locks you in to the prevailing economic conditions of the time.
For example, we have been through a period of Quantitative Easing (QE) which has increased the supply of money and forced gilt yields down, whilst QE may return in the short term it is unlikely to continue in the longer term. Gilt yields have also fallen due to money leaving Europe in droves, due to the lack of stability in the Euro. Funds have therefore been moving to safe havens, such as Sterling, this again has the effect of reducing gilt yields. Finally, low interest rates have again forced gilt yields down.
There are of course other factors that may push Annuity rates even lower, for example the European directive known as Solvency II which may well have the effect of reducing rates still further.
The point however is a simple one, if you lock into a Lifetime Annuity now; you do so in the economic climate of that period. There is clearly no guarantee that Annuity rates will rise, there could be a case for delaying that decision until a later date.
Rightly or wrongly, most people buy a level Annuity. Assuming we do not live in a prolonged period of deflation, which whilst possible is generally thought of as unlikely, a level lifetime annuity only guarantees a pay cut for the rest of your life.
What will your income purchase in 20 years with a 5% inflation rate? £1 today would be worth just 38 pence!
Remember, pensioner inflation is traditionally higher than standard inflation. Also bear in mind the current energy situation; will the underlying price of oil and gas go up or down in the future?
What effect will this have on your buying power?
Delaying the decision may help you lock into a better Lifetime Annuity rate in the future, which is more in tune with the prevailing economic climate at the time of purchase.
Unlike a Lifetime Annuity a Fixed Term Annuity can provide a lump sum on death. This currently applies only up until age 75, however the new legislation which is being introduced will allow lump sums to be paid on death past this age.
You may feel that your personal circumstances are stable, that you have reached a stage in life where nothing will change materially. But, as with the rest of your life, things do change and this is where a more flexible Annuity can come into play.
Take an example where you have purchased a joint life Lifetime Annuity and your spouse unfortunately pre-deceases you. You are left with a lower income that otherwise you might have received as you have paid for the benefit of a spouse’s pension, something that will never be used.
As we all know, a Lifetime Annuity can never be changed, take a long hard look at your circumstances before you lock into a product that could be with you for more than 30 years.
Change in legislation
A great example of this was seen recently when the new Government have confirmed their commitment to raise the age of compulsory annuitisation beyond age 75, or even remove this all together.
This change may be of significant benefit to many, however those who have locked into a Lifetime Annuity will not be able to benefit from such changes as their Annuity cannot be changed.
As with all financial products Fixed Term Annuities are not without their drawbacks, they are more complex than a Lifetime Annuity and the income levels are often lower, generally by about 10%, than a Lifetime Annuity.
However, the added flexibility both during the life of the annuitant and on their death may compensate for the drawbacks.
The decision how to create an income from your pension fund is perhaps the biggest and most important financial choice you will ever have to make, take time to make it, consider all the options, and most importantly take independent advice – it can only improve the decision you make.