The reputation of annuities has come under fire in recent years. Despite their previous popularity, many consumers now shy away from the product when considering viable retirement income options.
However, is such reticence justified?
What is an annuity?
Put simply, an annuity is a type of retirement income that consumers can purchase using part or all of their pension pot. Annuities come in two main forms: a lifetime annuity, which pays retirees an income for life; or a fixed-term annuity, which provides fixed income for a set period of time.
Annuities were commonplace prior to the introduction of pension freedoms in 2015 – this legislation allows those aged 55 and over to access their defined contribution pension. Indeed, consumers would often withdraw 25% of their pension as a tax-free lump sum, while the other 75% was usually used to purchase an annuity.
However, with greater autonomy over their pensions, consumers looked beyond annuities to alternative options, such as drawdowns, or investments offering higher returns. Consequently, sales declined. Indeed, before the pension freedoms, annuity sales ran at approximately 350,000 a year; in 2018, just 33,975 new annuity sales were recorded.
So, what drove this change?
Poor value and pushy sales tactics
Many consumers worry that annuities are “poor value”. The amount an individual receives from an annuity depends on a variety of factors – as well as one’s health and pension pot size, annuity rates are the main determining factor.
Annuity rates are calculated in accordance with average life expectancies and interest rates. Currently, interest rates are at historic lows of 0.1% and people are living longer. This will be off putting for many consumers.
Coupled with the value offered by annuity rates, the sales tactics used by some annuity providers has further deterred pension planners. In short, with the popularity annuities declining, some providers have resorted to enlisting sales representatives to drive uptake.
Unsurprisingly, the sales representatives are driven by commission, rather than the financial wellbeing of the client. They often lack the knowledge to clearly explain how annuities work. Instead, many rely on “pushy” sales techniques to pressure consumers into purchasing an annuity, rather than offering balanced advice.
Do annuities deserve their bad reputation?
The demonisation of annuities seems unfair. In short, an annuity is the only mechanism to secure a guaranteed income for life. If people cannot afford any risk to their income, disruption to their income or even a loss of income in retirement, an annuity remains the only option open to them.
However, the industry as a whole must reassess its approach to annuity sales. Instead of forceful sales tactics, the industry must focus on providing clear, jargon-free information about annuities. Consumers must be able to seek advice and recommendations based on their objectives and needs in retirement. Improving consumer access to independent financial advice is a necessary starting point. After all, annuities will not suit everyone, so it is vital that consumers seek advice and consider all their options based on their needs before making any decision.
Andrew Megson is the executive chairman of My Pension Expert, the UK’s number one Advised Retirement Income Specialist. Founded in 2010, My Pension Expert specialises in providing independent advice to UK consumers about their pension plans – it arranges millions of pounds worth of retirement income options each week.