Annuities: accept no substitutes?

23rd October 2014

In light of the upcoming pension system overhaul, Ian Sayers director general at the Association of Investment Companies, looks at the annuity conundrum…

If you order shopping from a supermarket online, you may have pondered over the ‘allow substitutes?’ box.  Trawl the internet, and you will be regaled with stories of inappropriate choices made by those tasked with making these crucial decisions.  Like the customer who ordered chicken wings, only to have them replaced by an equivalent number of whole chickens.

More recently the vegetable soup I ordered was substituted by something almost identical with ham in it.  Not unreasonable, given that bacon was in my order, but it was still rejected, as I don’t like particularly like vegetable soup, and my wife (who asked for it) is a strict vegetarian.

So whether you can live with an alternative not only depends on how much it differs, but also how important those differences are to you.

Likewise, people looking at our research into the performance of the UK Equity Income sector might have equally strong views on whether or not this might be an option for them in retirement.

If you can live with the risks to income and capital, and aren’t desperate to maximise income in the early years, you may well find this an appealing alternative to an annuity.  After all, your £100,000 would have returned £113,664 in income over 20 years, would be yielding more than 8% on your original investment, and your capital would have more than doubled to £222,315.  But if a higher immediate and totally secure income is your priority, then investment companies simply aren’t for you.

As some commentators have noted, a person retiring 20 years ago and purchasing a level annuity would have received an annual income of £11,500.  This is a fair point, even if the income of £230,000 is less than the total profits made by the UK Equity Income sector of £235,979.

But I can’t help feeling that, if annuities were still offering 11.5%, then most of the reforms we have seen in the last few months would never have materialised.  And it still wouldn’t help someone, and there are many, who see the ability to hand on assets after death as a priority.

The real benefit of the pension reforms is that someone’s financial planning in retirement can be tailored to their needs.  It cannot just be summed up as ‘annuity or not’.

Or, to put it another way, its horses for courses.  Which reminds me to tick the ‘no substitutes’ box the next time I order lasagne online.

 

 

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