|Everybody hates them because they
are associated with the compulsion of the pensions regime. But
they have their place.
An annuity is....
..... a dead simple idea. You pay a capital sum. In return you receive
an annual income until you die. The annual income is called an 'annuity'.
You have 'bought an annuity'.
The trouble with planning for death is you do
not know when it will come. If, sensibly, you plan to spend all
your money before you die you do not know how quickly to do it.
An annuity passes that problem to someone else.
A standard annuity pays a fixed sum until death. But there are as
many different varieties as there models in the Ford range. And
for the same reason: every kink and tweak is an attempt to widen
the market for the product. Here is a partial list that will be
- Payments can be inflated at a fixed rate
- Payments can be linked to the Retail Prices
- Payments can be linked to a stockmarket return
- Payments can be garanteed for 5 years even
if the annuitant dies
- Annuities can be on joint lives - payments
continue until you both die, often with a reduction after the
Annuity rates are quoted in percent. Today
a 65-year old male non-smoker can buy a standard annuity for about
6.8%. That means that if he pays £100,000 he will receive
£6,800 every year until he dies. That
sounds pretty good, when the best you can get on a savings account
is 5%. But there is a catch.
You must remember that you never get your capital
back. But with a savings account you do. And that makes a big difference.
We don't want to get bogged down in the maths
here. So just take our word for the following, based on the above
- if he lives to age 85 his investment return
- if he lives to age 90 his investment return
- if he lives to age 92 his investment return is
- if he lives to age 100 his investment return
So, in this simplifed example, he does not buy the
annuity if he expects to die before age 92. But only if he is happy
to live on nothing if he unexpectedly reaches the age of 93!
Like so many savings decisions, only you can
decide whether an annuity is right for you. Annuities have a bad
reputation because the pension regime demands that you buy them
whether it makes sense for you or not. But that does not make them
bad for everyone.
What you must do is treat annuities like any other investment. Do
your sums, and evaluate them carefully against the other ways you
might provide for your retirement.
Otherwise, with such a wide variety of annuities
available it is difficult to give generic advice. But here are some
things that you should watch for:
- Tax: Annuities are partly taxed as income
and partly treated as a return of capital (and therefore untaxed).
The proportions depend on the product. Insist it is clearly explained
- Cost: These are insurance company products,
and therefore support a high level of spend on marketing and commssions
to financial advisers. You are paying for that.
- Inflation:...will erode the spending power
of your fixed annuity. You can buy more complex annuities that
try to address this, but....
- Complexity (1): When you go to a car showroom
to buy a bog-standard Mondeo a good salesman will send you out
of there with special wheels, 16-valves and all sorts of stuff
that you did not realise you needed. Because that is where the
profits are. Annuities are the same.
- Complexity (2): When you trade in your old banger
for your new Mondeo the salesman will always try to quote a net
price for the deal. Because he knows that he is likely to make
a better trade than if he disentangles the deal into separate
prices for the new car and the old. It's the same for annuities.
- Inflexibility: Annuities are irreversible.
- Supplier risk: If your insurance company
goes under, so does its promise to pay your annuity. Heed the
warning of Equitable Life. Your investment return must include
a risk premium.