Annuities, especially enhanced annuities, will continue to play an important role in retirement planning and income despite predictions of their demise in favour of drawdown, Billy Burrows has said.
Burrows said in his latest paper, The Case for Annuities, while pensions freedom has broadened retirees’ options, annuities and the guaranteed income for life they provide would logically still form part of retirees’ income strategies.
The report, sponsored by enhanced annuity provider Partnership, explains future retirement planning will feature more sophisticated use of annuity products coupled with a deeper understanding of behavioural issues that drive decision-making.
The paper also argues an increase in personal underwriting will further increase annuities’ attractiveness.
It also looks to explain mortality drag, which Burrows describes as an “invisible force” that provides an important boost to annuity payments.
He said mortality drag makes it harder for drawdown policies to provide the same level of income without the investor taking “undue risk”.
Burrows explained that when someone buys an annuity they benefit from the mortality cross-subsidy – meaning people who die before their normal life expectancy subsidise those who live longer
However, people who invest in a drawdown plan do not have the opportunity to benefit from this mortality cross-subsidy.
The chart below illustrates the additional investment returns needed in order for a drawdown plan to maintain its annuity purchasing power each year for someone who qualifies for an enhanced annuity.
At age 70, the additional investment return required is nearly 4.73% return before charges, according to the report.
Burrows said: “It is important to separate the benefits of annuitisation from the poor image associated with some annuity policies.
“The case for annuities can be made strongly on a number of fronts when the benefits such as a guaranteed income for life are examined and the outcomes compared to products such as drawdown.”
He added: “As the mortality drag chart shows, annuities, especially enhanced, are hard to beat when compared to drawdown.
“The investment returns required to maintain the annuity purchasing power increase with age and this is the time when investors should be taking less risk not more.”
Partnership, the enhanced annuity provider which sponsored the paper, said it remained convinced of the benefits of its products but wanted to prove the point by getting Burrows on board.
Managing director Andrew Megson said: “This is a report that advisers and consumers can use to fully understand when and why annuitisation makes sense.
“Mortality drag is one of the least understood aspects of annuities and this paper helps to explain this phenomenon as well as clearly highlights where and why annuities still have an important place and are beneficial for many retirees.”