For a long time, annuities were the investment of choice for many retirees around the world but over the course of the 21st century the retirement landscape has changed considerably and individuals are now much freer to choose different types of investment.
Nevertheless, annuities often do still have their place in a retirement financial plan so I wanted to write a brief post explaining what they are and whether they should play a part in your retirement portfolio.
An annuity is at its most basic a tool to convert an investment into a series of guaranteed periodic income payments. It is most commonly used as a way for retirees to ensure that they have a guaranteed income for life, however long they live for. Annuities offer peace of mind to millions of retirees around the world. Whatever happens to other assets they might own, which are vulnerable to market forces, the income from the annuity is set in stone and will be paid until the holder dies.
Annuity rates are shown as the amount the holder will receive each year for $100,000 of investment. So if your annuity rate is 5% you will get $5,000 a year in income. The rate will vary depending on the life expectancy of the purchaser so the longer you are expected to live, the lower the rate. A 70 year old will get a higher annuity income than a 60 year old and someone who smokes or suffers from a condition likely to shorten their life will also do better than an annuitant of the same age in robust health.
Annuity rates tend to follow the same trajectory as interest rates because they are in part funded by the interest earned on the pool of cash that is invested by those purchasing annuities. That’s one reason why right now, as interest rates around the world continue to languish at historically low levels, annuity rates are extremely low. In fact, Which?, the UK’s largest independent consumer organisation, warned last year about plummeting annuity rates in the UK. According to an article written in September 2019 an average 65-year-old could buy an annual income of just £4,654 using a £100,000 pension, a 14% drop in just 8 months.
There are of course other factors at work when it comes to annuity rates such as a decline in the yield from bonds, which have been affected by the pessimism over the global financial landscape in general causing investors to switch their focus from shares to ‘safer’ investments.
With annuity rates so low you might wonder why anyone would consider them as an option for retirement income but the security of a guaranteed, inflation-resistant income remains attractive for many people. Many retirees combine the security of an income from an annuity to ensure that the essentials of life are covered, using income from other investments to cover non-essential retirement expenditure – the nice-to-haves if you will. That’s a good, balanced approach and if you do want to keep some of your assets in other investments a good option is a multi-asset portfolio or mutual fund with a solid track record but there is a wealth of alternatives out there.
Taking an annuity is a big decision, once you’ve parted with your cash there is no going back so you need to consider this option very carefully within the framework of an overall financial plan and do your homework to find the best annuity for your situation.
If you’re coming up to retirement and wondering what to do, I highly recommend that you seek financial advice from a professional. Choosing what to do with your retirement savings is one of the most important decisions you will make in your life and could really make a difference to how you live out your twilight years. A financial adviser will help you assess your requirements and balance them with the potential risk to guarantee you a secure retirement which will not be blighted by endless money worries.
I’m always happy to offer an initial free consultation to new clients looking to get their retirement planning sorted and would be delighted to help you make informed decisions about your future finances. Do get in touch at firstname.lastname@example.org if you could do with some professional guidance.