Retirement IQ

Learning the lessons from OMO

March 24, 2017 11:49

It always comes as a shock to me when I hear stories about people not shopping around for the best annuity rates because I assume everybody knew they could  get a higher annuity from a company with better rates.

But, of course, everybody did not know about the advantages of open market annuities as witnessed by the high-profile reviews into the market; Prudential's intention to withdraw entirely from the annuity market highlights the changing dynamics of the sector.

It is easy for people like me who lived in an ‘annuity bubble’ to think that everybody read the newspapers or listened to the radio, but in reality many people either did not listen or felt under some obligation to accept the offer from their annuity provider. It can be argued that some companies had a vested interest in making sure customers were kept in the dark so they bought annuities at low rates, thereby earning huge profits

I go on to talk about:

  • The blame game
  • The commoditisation of annuities
  • Increased sophistication in underwriting
  • Lessons

Read the article on FT Adviser

Spring budget 2017 and annuity trends

March 8, 2017 23:28

It was three years ago, in the March 2014 budget speech that George Osborne's declared "no one will have to buy an annuity”. Since then annuities have become more unpopular and sales have fallen by about 50%.

There was no mention of annuities and very little mention of pensions in the budget (probably because major changes were made in previous budgets) so no news was probably good news.

Annuity trends

If inflationary pressures increase as result of better than expected economic growth and increase in prices because of the weak pound, long term interest rates could rise. This would cause annuity rates to rise and consequently new pensioners would get more income when converting their pension pots into lifetime income.

After a promising start to the year when long term yields increased, the upward trend has reversed and over the last few weeks’ annuity rates have fallen by between ½ and 1 %. The benchmark 15-year gilt yield rose to 1.93% in mid-February but has fallen back to about 1.6%. However, it will not take much to recover this lost ground.

There could be trouble ahead

Perhaps the biggest fear for pensioners is the risk of falling equity prices after Article 50 is triggered caused by uncertainty in the economy. This means that those drawing an income by way of which pension drawdown could see the value of their pension pots falling.

No matter if annuities go up or drawdown funds go down, everyone should take stock after the budget and plan for the year ahead.

Pension planning in an uncertain world

February 13, 2017 15:14

Please read my latest article on the unbiased website

Pension planning in an uncertain world

Looking ahead in 2017

January 31, 2017 14:57

Looking ahead in 2017

This year I will be looking at the changing nature of the retirement income market. There are some big topics to get our minds around including;

  • the role of robo-advice
  • sustainable income levels from drawdown
  • the future for annuities
  • how to invest taking into account post Brexit economic conditions and Trumponomics

Each month I will look at how topical issues are impacting on retirement income planning but to start the year off I will take a quick look at the major issues that could influence the way advice is given and decisions made.

Trumponomics

I didn’t think Trumponomics was a real word until I looked it up and saw it described by Investopedia as the economic policies of Donald Trump who won the presidential election on the back of bold economic plans such as cutting personal and corporate taxes, restructuring U.S. trade deals and introducing large fiscal stimulus measures focused on infrastructure and defence. Trumponomics is dogged by a lack of consistency, coupled with a style of delivery that often leaves room for multiple interpretations, has made putting predicting what will happen to the US economy challenging.

In fact, in the short time between writing this and being published the incoming administration may have already made some policy announcements where the effects will start reverberating around the world.

I need say no more other than all eyes will be on the US to see what happens next.

Post Brexit economic conditions

With increased certainty about the UK’s negotiating position comes increased concern about how events may be unfold. It shouldn’t matter if you are a ‘glass half full or half empty’ person because although the future is uncertain there are several things to watch out for. The first is the impact of a weak pound which may translate into higher inflation and interest rate (see my comments on annuities below).

The second is the potential for ‘trouble ahead’ in the UK economy which may result in increased volatility in equity markets. If this proves to be case it will have been better have to have taken defensive action in advance rather than be caught on the hop. I may be wrong, but even if markets continue going up, it reminds us that sequence of returns risk is not an abstract concept but a real-world phenomenon.

Finally, there has been talk of relaxation for Solvency II which could help with pricing of annuities if less capital has to be put aside.

As with President Trump, look out for the unexpected.

The future for annuities

There should be no need for me to hark on about rising bond yields and rising annuity rates as this should be self-evident. Instead watch the relationship between annuity yields and the expected returns for lower risk drawdown portfolios.

If, and at this stage it is a big if, the yield on the benchmark 15 year gilt increases from the present level of 1.8% to 2.5% or more, and equity returns come off the boil, perhaps annuities will once again start giving drawdown a run for its money.

My instincts tell me that this dynamic may be the one to watch in 2017.

Follow annuity and gilt trends each week - this is a new chart

Conclusion

In conclusion, now that the dust has settled on pension freedoms and less people are taking their pensions as a cash sum, and with some much uncertainty in the world, deciding how best to convert a pension pot into income is probably one of the most complex areas of financial planning for middle Britain.

Will 2017 be the ‘Year of the Annuity’?

January 26, 2017 22:58

This an article I wrote for Professional Adviser and Retirement Planner - read the original article here

The Chinese may be celebrating the dawn of the Year of the Rooster this weekend, writes William Burrows, but could 2017 also see UK advisers and their clients celebrating the return of annuities as a viable alternative to pension drawdown?

If 2017 truly is to be the year of the annuity, several things need to happen. First of all, bond yields must rise significantly. Second, advisers and their clients need to be convinced there is a role for annuities now there is freedom and choice. In addition we need to have a better understanding of the various behavioural and technical factors that impact the decision whether to arrange an annuity or invest in drawdown.

I cannot predict how bond yields will move as the realities of Brexit and Trumponomics work their way through the economic system, but one possible scenario is that interest rates and inflation will rise in the UK (and the US) pushing bond yields upwards.

There is a simple rule of thumb – every 100 basis-point change in the underlying annuity yield results in annuity income increasing or decreasing by about 8%. I follow the 15-year gilt indices published in the Financial Times and currently it is 1.89%. This means that if the yield increased to, say, 2.5% during the year we could expect annuity incomes to rise by about 5%.

The benchmark annuity rate – £ 100,000 joint life annuity for ages 65 and 60 in good health, with two-thirds partner’s pension and level payments – currently pays £ 4,432 per annum. Those who smoke, take prescription medication or have a medical condition may qualify for a higher annuity but this is not ‘free money’ – it is only accelerating the return of the original capital to reflect reduced life expectancy.

It is easy to make a comparison with the 4% drawdown rule and conclude there is no point in purchasing an annuity when the amount of sustainable (level) income is similar from both options. This can be misleading, however, because an annuity is return of capital and interest and the annuity income stops on second death, whereas drawdown provides a lump-sum death benefit. On the other hand, the annuity is truly sustainable in that it is guaranteed for life whereas drawdown is not normally guaranteed.

A viable alternative?

This begs the question – at what levels do annuities become a viable alternative to drawdown? The short answer – and this is a pure guess based on my intuition and experience – is that if the benchmark yield increases to 2.5% we could see the benchmark annuity get close to the £ 5,000 mark and risk averse investors will find the returns from annuities more acceptable.

The easiest way to see this is to look at my annuity charts at Retirement IQ but you will notice from the following chart that the benchmark annuity was paying close to £ 5,000 in July 2015 when the yield was around 2.5%. We need to go back to October 2013 to see the benchmark yield above 3% and annuity income nudge towards the £5,000 level.

See latest chart

Now, you may of course reasonably point out that an extra £500 a year before tax does not buy much and yet it is not just a question income – it is also about risk.

A longer answer – and this requires advisers and their clients to be convinced there is a role for annuities alongside drawdown – is that, as we travel through more uncertain times, behaviourally and technically the case for annuities becomes stronger.

Behaviourally, people place a higher premium on peace of mind and security as they grow older, especially if they are concerned about world events. Technically, as people grow older, the benefits from mortality cross-subsidy increase and the break-even rate between annuities and drawdown changes in favour of annuities.

There is still a long way to go before we can argue annuities are such good value they are a 100% replacement for drawdown. We are, however, close to the time where we can argue most people should have some annuities as part of a risk-averse portfolio of retirement income options.

Should you wait for a higher annuity?

December 29, 2016 15:30

Sam Brodbeck wrote a very good piece in the Telegraph on 23rd December looking at the prospects for annuities in 2017.

One of his points is that annuity rates may rise in 2017 if inflation increases in response to Brexit and Trump's economic policies.

Sam writes -Annuity rates are at rock bottom levels, but with Donald Trump's election likely to fuel inflation, many think rates could be about to improve.

Financial markets have so far interpreted Donald Trump’s election as likely to fuel rising prices after years of very low inflation.

His promise to spend huge sums on national infrastructure projects - coupled with the US Federal Reserve’s recent interest rate hike - should in turn lead to a rise in the yields on government bonds, both in America and Britain.

I am quoted 'Billy Burrows, an annuity expert at Retirement IQ, an advice firm, explained that the 15-year gilt, seen as a benchmark rate, is likely to end the year yielding 2pc. He said for every percentage point increase in gilt yields, annuity rates rise by around 7pc. “Increased inflation is one reason why yields may increase and if yields go from 2pc to above 2.5pc this should result in about another 3.5pc increase in annuities and at these levels they will be much better value,” he said. For a £100,000 savings pot this means rates will rise from around £4,400 a year level annuity to around £5,000. Mr Burrows said if you do not need an income immediately it could be worth holding off and benefiting from higher rates. But trying to guess future annuity rates presents the same problem as attempting to time investment markets, it is a foolhardy task.'

Read the article here - http://www.telegraph.co.uk/pensions-retirement/annuities/should-wait-higher-annuity-rate-thanks-donald-trumps-inflation/

Annuity review 2016

December 15, 2016 22:29

Annuities 2016/2016

Annuities may be much less popular after pension freedoms but annuities are still important and annuity rates must be monitored.

Before pension freedoms which started in 2015, over 300,000 people a year converted their pensions into a guaranteed stream of income payments by purchasing annuities but since pension freedoms when people can decide whether to take their pension pot as a cash sum, annuity or drawdown, the sales of annuities have fallen through the floor to about 80,000 annuities per annum according to the Association of British Insurers (ABI).

There are three reasons why annuities should not be sidelined or ignored:

  • Annuities are still the only policy that can guarantee to pay a fixed income for life no matter how long the policyholder lives without any investment risk
  • They provide the benchmark as to the optimum income that can be taken from a pension fund
  • They can be used to de-risk pension income solutions in later retirement

Annuity rates in 2016

I have been collecting information on annuity rates since 1990 and annuity rates fell to their lowest levels ever in 2016. The graph below shows how the income from annuities for those in good health has continually fallen since 1990 and they reached the lowest ever levels in September 2016.

See latest chart

Annuity (left axis) is for age 65, £10,000 purchase, single life, guaranteed 5 years and level payments. The yield (left axis) is 15 year gilts. The FTSE 100 (right axis) is a share index of the 100 most highly capitalised UK companies listed on the London Stock Exchange and shows how a pension fund invested in equities may rise or fall in value over time.

The benchmark annuity, £ 100,000 joint life annuity for ages 65 and 60 with 2/3rds partner’s pension and level payments was paying £ 5,263 per annum gross in December 2013 and despite some up and downs the same annuity was paying just under £ 5,000 per annum 12 months ago, but today the income is just £ 4,367, a 22% fall over 3 years, 12 % over the last year.

At the lowest point in 2016 this annuity was only paying £3,802. Clearly timing of an annuity purchase is critical and someone buying at the lowest point in 2016 would have locked into a £ 1,000 less income compared to the best rate at the beginning of the year.

The reason why annuity rates have fallen is simple. Annuities are priced in relation to the yield on fixed interest investments and these yields have plummeted, especially after the Brexit vote in the summer. For example, the yield on 15 year gilts fell to an all-time low just above 1% in late summer before bouncing back to just below 2% by mid-December.

Annuities are also based on average life expectancy and as people are living longer annuity incomes are adjusted downwards because they are being paid longer. Anybody who smokes, is taking prescription medication or has a medical condition may get a higher annuity if they apply for an enhanced annuity. Companies such as Aviva, Canada Life and Legal & General will pay higher incomes for those in poor health.

Reduced competition

Although, interest rates are the main factor for annuity pricing, downward pressure on rates has resulted from a fall in demand, lack of competition and reduction in the number of insurance companies offering open market annuities.

In 2016, Prudential announced it was pulling out of the open market annuity market and Standard Life and LV= are also pulling out of the annuity market.

These leaves Aviva, Canada Life, Hodge Life and L&G competing for good health annuities and they are joined by Just Retirement, Retirement Advantage and Scottish Widows in the enhanced annuity market.

No secondary annuity market

Plans to allow people to sell back their annuities to insurance companies in return for a cash sum have been shelved. Although many experts welcomed the U turn on what was regarded by industry professionals as an ill-conceived idea, many customers are angry that the option to convert their low value annuities in to cash has been taken away.

Annuity rates in 2017

The good news is that annuity rates are bouncing back as yields and it seems likely that the benchmark 15-year gilt will end the year at about 2% compared the lowest point of just over 1% in September.

The maths is complicated, but generally speaking, for every 100 basis points increase in yield (e.g. from 2% to 3%) we can expect annuity rates to increase by about 7%.

Increased inflation is one reason why yields may increase and if yields go above 2.5% this should result in about another 3.5% increase in annuities and at these levels they will be much better value.

If the income from the benchmark annuity, currently about £ 4,400 rises to about £ 5,000, we should see a resurgence in interest because at these levels annuities are a more viable alternative to drawdown.

Value for money

If you are 65 and purchase an annuity for £ 100,000 today you can get just under £ 4,400 per annum for life but how do you know if this is good value?

There is a quick and easy way of working this out. Think of an annuity being like a mortgage in reverse. The insurance company will pay you back your initial capital with interest over the rest of your life. If on average a 65-year-old will live for another 25 years it is like a 25-year-old mortgage in reverse. At current rates this suggest an underlying interest rate of less than 2%.

If you think you can invest your pension pot in drawdown and get more than 2% investment return per annum after charges you may be able to get a higher income over the longer term than from an annuity but you will be taking the risk and complexity of investing your pension pot.

Annuities v Drawdown

The main alternative to an annuity is drawdown. An annuity is a form of insurance because it insures you never outlive your income and run out of money whereas drawdown is an investment option where you take income withdrawals from your pension pot.

There are two important aspects of drawdown; the amount of income you take out and the rate of return on your investments. If you take out too much income and or the value of your investments fall you could run out of money.

It is impossible to predict the future, but if the UK economy is going to go through uncertain times as a result of Brexit, the stock market could suffer and consequently pension funds would fall in value.

2017 – A better year for annuities

2017, could be the year in which annuities become more popular as rates rise and drawdown becomes less popular because of economic uncertainty.

If as predicted, interest rates in the UK start to rise and the prospects of higher inflation results in higher bond yields, this should translate into higher annuity incomes.

If, the annuity alternatives such as drawdown become less attractive because of stock market uncertainty more people may change their preference for income flexibility in favour of guaranteed income.

No matter how 2017 pans out, it is very unlikely that annuities will be battered as much as they were in 2016.

Mind the annuity gap

December 9, 2016 23:58

The OECD Pensions Outlook – Mind the annuity gap

The OECD has just published its Pensions Outlook 2016 and it is essential reading. There are several things that jump out of the pages; first is the importance of financial advice and the need to fill the advice gap and second is the importance of annuities.

Advice gap and annuities

The report says that policy makers need to ensure that people receive retirement advice that is appropriate for their needs and they need to make sure that advice is accessible and to those with moderate financial wealth because there is an advice gap in the UK.

The report also talks about the importance of annuities and partial annuitisation and warns about the possible detrimental effects of the decline in annuities in the UK following pension freedoms.

My first reaction is that this is all very obvious to those who operate at the coal face of pensions so why is there such a disjoint between the so-called experts and policy makers?

Populism

We can’t just blame policy makers for the mess we are in because there are other forces at work not least the move towards ‘Populism’. In short, the public has increasingly become sceptical and untrusting of the so-called experts so that have looked elsewhere for their information and advice.

I totally agree with the sentiment behind pension freedoms and have been consistent calling for the end of compulsory annuitisation but I disagree with the direction of travel for retirement income solutions. In short many people are discounting the benefit of guarantees and long term solutions in preference for short term monetary gain. Why consider a sustainable lifetime income when you can take your cash when you want?

So how can we get ourselves out of the mess created by a such a wide advice gap? Perhaps the answers can be found in bridging the gap between the behavioural and technical side of the equation.

The behavioural and technical side

On the behavioural side, many people have a long list of misconceptions; advice is complex and expensive, annuities are lousy but drawdown is better, cash in hand is better than long term income. On the technical side, sequence of returns risk is not theoretical but a real risk that can seriously damage a drawdown plan, the mortality cross subsidy in annuities is very small at younger ages but increase with age and inflation erodes the spending power of a fixed income.

The problem for many people is that the behavioural factors are given more importance than the technical factors because they trust their own instincts and they don’t understand the technicalities. A good adviser will not only nudge and challenge some of the behavioural misconceptions but will explain the complex issues and recommend the solution that will produce the best outcome.

In conclusion, what is needed is not yet another report telling us what we already know but some practical actions that will close the advice gap and result in better outcomes which may include partial annuitisation.

Annuities are my special subject

Annuities are my special subject and I have argued for over 25 years that most people will benefit from purchasing annuities as they get older because not only do they provide guaranteed income they help reduce the overall risk of a drawdown plan. However, I also argued that decisions about annuities need to be considered in the context of value for money. It is an uncomfortable truth, but even though there is a strong behavioural reason for purchasing annuities, there are many technical reasons why now is not the best time to purchase annuities because interest rates are so low.

Bond yields may increase next year as a result of post Brexit inflationary pressures and the equity markets may come off the boil so this will strengthen the case for partial annuitisation.

Billy Burrows

Director, Retirement Strategy

Can annuities survive yet another setback?

November 20, 2016 17:10

Read story in Money marketing

Have annuities have been Trumped!

November 10, 2016 09:28

Annuity rates post Brexit and the US election

With so much happening in the world is anyone interested in what is happening to UK annuity rates?

Whilst most people have more important things to worry about, those approaching retirement or who are drawing an income from their pension pots should be very interested in the current state of the annuity market.

The decision whether to purchase an annuity or take an income from a pension drawdown plan is one of the most difficult decisions in personal finance and one that has far reaching consequences so it is important to understand what is happening in the pension market.

Annuity rates may be affected by the US election result

At times of economic and political uncertainty there is normally a flight to quality which means that investors shift from equities to bonds and this results in a fall in gilt yields.

On Wednesday 9thNovember global financial markets responded negatively to Donald Trump’s election success but by Thursday markets had mostly reversed these negative reactions. It seems the markets may be taking the unexpected election result in their stride so we might avoid a post Brexit style fall in yields.

Although annuities are invested in corporate bonds and even property, the yield on long term gilts is the benchmark for pricing. This means that if gilt yields fall, the income from annuities also fall. The reverse is also true.

It is too early to come to any firm conclusions but it does seem that the slow but steady rise in annuities (see below) seen over the last few weeks will probably be put on hold and may even be reversed for a short time.

In the longer-term some analysts are forecasting higher US interest rates if Trump's key policy priorities which include generous tax cuts and higher infrastructure and defence spending, along with deregulation for banks come about.

Annuity rates are bouncing back after Brexit

The unexpected Brexit vote in June resulted in annuity rates falling off a cliff. In the last week of July annuity rates from all the top providers fell by between 2 and 3% a result of the dramatic drop in bond yields following the unexpected referendum vote. Since then annuity rates have bounced back as the benchmark 15-year gilt yield has risen from just above 1% in late August to 1.7% on 9th November. The benchmark annuity* rate has also reason. It is now paying £ 4,086 per annum gross for £ 100,000 purchase, which is a rate of 4.086% compared to £ 3,928 at the beginning of September.

This might seem a small change but translated into real money, somebody with a £100,000 in a pension pot can now get about £150 a year more for the rest of their life compared to September.

The rates are still well down compared to a year ago and rates will not get back to this level unless there is a significant increase in yields but every increase is a step in the right direction.

The table shows how annuity rates have fared over the last 5 years.

 

*£ 100,000 purchase, joint life 2/3rds annuity, ages 65 and 60 with level payments.

What is the short and long term outlook for annuities?

Events are moving very quickly and it is very difficult to form a view about the future. My own views are changing as events unfold. In the past there have been other factors influencing annuity pricing such as Solvency II, increased life expectancy and the impact of pension freedoms. This downward pressures now seem to have less impact so the fate of annuity rates rests with the direction of travel for yields.

One force which could impact on yields is the likely increase in inflation resulting from the post Brexit weak pound which makes imports more expensive. The price of Marmite is going up so the income from annuities should also go up. The connection is that inflation not only increases prices but also results in higher yields.

Conclusion

The impact of Donald Trump in the White House should not change the slow but sure increase in UK annuity rates in the longer term but it might stall the trend in some short term.

Annuities have been trumped by drawdown since pension freedoms but if rates continue to rise it might be time to play the annuity card.