‘Mortality risk versus investment risk’ of annuity pensions

Time was when the defined contribution pension holders had no choice but to purchase an annuity on retirement, a contract with a life insurance company that agrees to pay you a series of pension payments, normally monthly, until you die.

But as annuity rates are linked to interest rates, it historically led to concerns in the run up to the fateful date. For anyone buying when rates were high, happy days. Buy in the wake of a crisis, however, and not so much.

Live long and beat the actuary? Again, happy days. Drop dead carrying your carriage clock home and, unless you remembered to include a spousal benefit, your entire pension pot died with you, or at least, skipped back to the life assurance company.

There's an inflexibility with annuities that may put some people off too

Over the past 20 years the pensions landscape has been transformed thanks to the introduction of approved retirement funds (ARFs). These days, you’d be hard pressed to find anyone buying an annuity.

"I've worked in pensions for years and I've only once come across someone buying an annuity," says Fergal Roche, financial planning manager pensions at Davy.

If you’re one of the lucky members of a defined benefit scheme, you may never have to make a decision about buying an annuity at all, as your scheme’s trustees will either pay your pension directly or buy an annuity on your behalf.

Anyone else should take advice when considering their purchases.

There are some circumstances in which a person might opt for one. For example, where the retiree is significantly older than their spouse, they might like to buy an annuity with a spousal element, on the basis that their partner will be in receipt of a guaranteed income should anything happen to them.

With an ARF, whatever is accumulated in the person’s retirement savings fund becomes part of their estate when they die. If a person has no family to pass this money on to, he or she may prefer to opt for the security of an annuity instead.

Interest rates

However, with interest rates low, so too is interest in annuities. “Right now, if you walked into a life company to buy a pension for a 65-year-old and wanted an element of spousal reversion in it if you die, you’d be doing very well to get a rate of 3 per cent,” says Roche.

An annuity rate of 3 per cent on a pension pot worth €1 million amounts to €30,000 a year.  With rates so low, “to buy a pension, you need a bigger pot than you used to. Also, we are seeing inflation, so that is eating into it too,” he points out.

"Very few people go for annuities anymore," agrees Brian Kingston, retirement and financial planning manager at Brewin Dolphin Ireland.

“Some very old contracts still exist for guaranteed annuity rates but these days only someone who wants absolute clarity in relation to income in retirement, who doesn’t want to take any investment risk, and who is in good health and expects to live a long time would consider it. It’s mortality risk versus investment risk.”

There’s an inflexibility with annuities that may put some people off too. It’s part of the reason why it’s so important to take impartial professional advice before making such decisions.

“If you buy an annuity today, you are locked into it for life,” cautions Kingston. “However, if you buy an ARF and in five years’ time change your mind and want to buy an annuity, you can do so.”

If your circumstances change at a later date, that guaranteed income may look more appealing. What’s more, you might get a better deal. “The older you are, the higher the annuity rate you are offered,” says Kingston.