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The fluctuating popularity of the annuity

July 18, 2016

Outside influences impacting our economy continue to reap havoc with investments and pensions.  Individuals must be poised, ready, if necessary, to amend personal finance plans to minimise any potential shortfall.

 

The UK’s bitter divorce from the European Union (EU) is expected to take at least 2 years and until new trade deals are agreed and markets are stabilised, the UK economy will remain in flux.

 

Pensions are no stranger to enduring measurable periods of instability and the recent vote to leave the European Union (EU) will be no exception. The usually perceived safe option of the annuity is showing itself to yet again fall foul of changing government legislation.  

 

In its most simplistic terms, buying a lifetime annuity to access a pension pot in retirement effectively guarantees the retiree an income for life, regardless how long they live.

 

If an individual presents all the signs that they will live to a ripe old age in retirement then an annuity is usually seen as a safe and lucrative option.

 

Annuities first saw a significant decline in popularity following the introduction of pension freedoms which came into force in 6 April 2015.  This is because they were considered to be less flexible than pension drawdown alternatives that would enable retirees to keep a pension invested, take an income from it and a lump sum without needing to buy an annuity.

 

The decline in popularity of the annuity post pension freedoms was fairly short lived as individuals soon became savvier to the risks associated to drawdown.  Two such risks are completely running out of retirement money and the impact of poor investment performance due to market turbulence.

 

As a result, The Association of British Insurers reported resurgence in popularity of the annuity in quarter four of 2015: annuity sales rose to £1.1bn compared to £660m being taken as lump sums via drawdown.  Sadly, the fallout from Brexit is likely to negatively impact the recent good fortune of the annuity yet again.

 

Annuity providers will invest money to ensure that there is enough money to keep paying the incomes of the retirees it has on their books.  However, they will avoid the high risk investments of the stock market, instead choosing to invest predominantly in gilts: essentially a short-term loan to the Government which pays interest. It is these gilt investments which underpin the value of annuities, because they tend to carry a lower level of risk and be guaranteed by the Treasury.

 

Following the vote to leave the EU, investors have been quick to move their money to the safe haven of gilts while waiting for markets to stabilise. This move has caused gilts to soar in value and because gilts pay a fixed interest rate, the effective pay-outs, known as the yield have dropped. This in turn has caused the effectiveness of the product to reduce, making it harder for pension providers and schemes, which rely heavily on this 'safe' stream of income, to afford to fund decent retirement pay-outs for ordinary savers.

 

It is an essential time for retirees to be aware of the impact of Government decisions on personal finance. Financial advisers will be best placed to ensure that any necessary changes to personal wealth portfolios are made in good time to roll with the punches.

 

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