Annuities for income

As the Iranian conflict intensifies and the risks of a serious global energy crises increases, global financial markets are in meltdown, but what about annuities. If equity prices are going down annuities are going making it a good time to consider the role of annuities in helping to de-risk retirement portfolios.

Don’t’ panic sounds patronising

Don’t panic and stay invested is the message from almost every investment house and many advisers at the moment. I wrote my own version of a ‘don’t panic’ email to clients but with an important caveat. I said it was patronising to say don’t panic when there is so much uncertainty in global financial markets and many people are genuinely worried about the value of their pension pots especially at retirement age.

But there is no need to panic but with an important caveat; providing you are invested correctly in the first place and have a good retirement plan. This begs the question, ‘what is the correct way to be invested and what is a good plan’?

What is the correct way to be invested and what is a good plan?

Working this out is easier said than done because there are so many different moving parts and different solutions. One the product solutions that can help de-risk investment strategies and improve planning is annuities, especially at a time when annuity rates seem likely to increase and remain high for the time being.

As all good advisers know, annuity rates are directly linked to the current yield on long dated bonds and the yield on 15-year gilts acts a useful benchmark. Just before the latest Iranian conflict which started on 28th February, the yield on 15-year gilts was about 4.7%, but by the 20th March it was up to around 5.2%. This suggests that annuities will increase by a few percentage points but there is always a time lag. One of my observations is that annuity providers are generally quick to cut rates when yields are falling but slow when yields are rising.

Annuities for income

If I am asked the question ‘what is the likely trend for annuity rates over the next few months’, my reply is that it all depends on yields which will be influenced by the outlook for inflation which will be affected by the price of energy. War may be bad for the equity markets but it will result in higher annuity rates.

So how can higher annuity rates help to de-risk investment strategies and contribute to better planning?

Annuities can be seen both as an insurance against outliving your pension pot or as a guaranteed investment option.

As the amount of guaranteed income generated by an annuity increases the more attractive, they become for those looking to secure their retirement income and benefit from the peace of mind and security that annuities provide. It also becomes harder for those taking income through pension drawdown to match the income from annuities without taking undue risks.

But it is not all plain sailoring because the amount of annuity income is the product of both the amount of money available to purchase the annuity (the value of the pension pot) and annuity rates. Annuity rates may be going up but pension pots invested in equities will be going down so one may cancel out the other. This means that those with cash or assets which retained their value may think it is a good time to lock into an annuity.

Annuities – an investment option

It may seem counter-intuitive, but annuities can also be seen as an investment option. Firstly, those wanting to increase the gilt or bond exposure in their pension pots while taking an income may be attracted to the risk free and high yielding returns from annuities.

Secondly, fixed-term annuities (which I maintain are really a sub-set of pension drawdown) have an option for no income but maximum guaranteed maturity value. This means that a 5-year fixed term can produce an annual return equivalent to about 4.5% which is much higher than most other fixed return options.

Watch out for the next market shock

We have experienced a number of shocks to financial markets recently; Covid, Ukraine, tariffs and now Iran and each time we have been fortunate that markets recovered relatively quickly thereby justifying the don’t panic and stay invested mantra.

It is too early to predict how quickly markets will bounce back from the current crises but perhaps one day there will an event from which markets will not bounce back for a long time. This thought should be enough to prompt retirement planners to revisit the retirement advice for their clients and make sure they have strategies to cope with the heightened global risks. In my opinion, arranging annuities whether lifetime or fixed term are a good way to help clients to achieve some additional peace of mind and financial security.

The Annuity Project is hosted by William Burrows and provides unbiased information on annuities and pension drawdown.

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