Annuities have turned out to be fabulously profitable for Britain’s pension companies – and something of a disaster for many of those forced into them before pensions freedom began in 2015.
Only now is it beginning to emerge just how awful those annuity rates were. An annuity is basically an income for life, and once the contract is taken out, you can’t exit it. But the pension companies that sold the elderly a dud are now helping themselves to a multibillion-pound windfall.
The sums are staggering. The pension companies based their annuity rates on projections of how long people at 65 were likely to survive. But they got their projections wrong: it turns out we are not living as long as expected. Just last week the actuaries clipped six months off projected life expectancy, with the projections now 13 months lower than in 2015.
What it means is that the pension companies won’t have to pay out as much annuity money as they originally provided for (and charged people for). Rather than handing it back to these it overcharged, locked-in pensioners, the industry is handing it to shareholders. Last week Aviva “released” £780m of cash that had been set aside to pay annuities. M&G Prudential released another £441m – 27% of its operating profit. Legal & General found £433m, while Phoenix chipped in another £205m.
City analysts say this shareholder bonanza will go on for another seven years, as the pension companies adopt new, lower life-expectancy, mortality tables. Maybe £4bn is a conservative estimate – it could be billions more.
The pension companies argue that it’s all swings and roundabouts: they took on the risk of guaranteeing a payout and, when markets fell in 2007-08, they took quite a hit. I also happen to know of one annuitant (that’s you, Dad) who bought an annuity paying 14.5% at the end of the 1980s. The annuity company is, 29 years later, still paying out as he reaches his 93rd birthday. My dad has had his initial annuity investment repaid many times over. But we can assume that with reserve releases running to the billions, winners such as him have been the exception not the rule.
Meanwhile, an extraordinary thing has happened to annuity rates in the past two years: now that no one is forced to buy them any longer, the rates on offer have miraculously improved. In 2016, the best buy for a £100,000 pension pot was a guaranteed income of just £4,495, but today that has risen to £5,551 – a 23% rise, even though gilt yields (used to price annuities alongside longevity) have not materially changed over the period. Maybe some of this rise is because of the decline in longevity, but I suspect it’s because pension companies have had to come up with better rates to attract buyers now we’re no longer forced to buy annuities.
Should you buy an annuity now? At these rates they are no longer the appalling value they once were. They should also rise a bit over the next few years as the longevity reductions are priced in.
Many advisers recommend a mix of “drawdown” with annuities. With this, you buy an annuity to cover your basic annual living costs, then draw down the rest of your money as and when you need it.
So how much will you need for that? Let’s assume you envisage needing £20,000 a year in retirement as your basic income, and that you get the £8,546.20 full state pension. That leaves you needing to buy an annuity paying £11,453.80 a year – which in turn means you need a pension pot of at least £207,000, according to figures prepared for Guardian Money by Hargreaves Lansdown. An awful lot of people will struggle to get to that level of saving.
There are also lots of alternatives paying the sort of income an annuity provides, without locking up your money and losing it all if you die early. Plenty of high-income bond and equity funds yield 5%, although there are charges to pay, and potentially severe volatility at times.
But here’s a thought: if you buy an annuity from Aviva, it will give you an income of about 5%-5.5% a year. But if you buy shares in Aviva on the stock market, they are currently yielding 7%. And if the analysts are right and the “releases” from the annuity reserves have only just begun, then those dividends might gush for years to come.
Where do you buy an annuity? One great resource is the government-funded Money Advice Service at moneyadviceservice.org.uk, You can input your individual situation and it will generate a free and impartial quote.
How much will you get for every £100,000 of pension savings?
The figures show the annual income that the pension company will give in exchange for £100,000, with the income guaranteed for life, with the choice of either ‘no annual rises’ – the payment stays level across the person’s entire retirement, or ‘with annual RPI increase’ where the person’s payment rises every year in line wit the retail prices index.
Age 65 no annual rises
Age 65 with annual RPI increase
Age 70 no annual rises
Age 70 with annual RPI increase
Source Money Advice Service moneyadviceservice.org.uk