Enhanced annuities used alongside drawdown and hybrid products
Andrew Pennie, head of Pathways, Intelligent Pensions considers the use of enhanced annuities as standalone products and as complements and alternatives to drawdown and hybrid solutions post pensions freedoms
As clients are living longer, providing the right advice for them in retirement has never been so important, especially in light of the pension freedoms introduced by Chancellor George Osborne. Finding the right solution will depend on understanding each of their personal circumstances, objectives and how the variety of available retirement income solutions can be used to meet their ever changing needs.
When selecting a retirement income solution, it is important that clients understand that they are able to shop around for the best deal. Too many people just stay with their existing pension provider and many retirees find better deals, and more money in their pocket, by searching elsewhere and this is of course where advice and correct planning come into its own.
As we know, there are four main options to consider for clients:
1. Flexi access drawdown
2. A lifetime annuity
3. Annuity drawdown (hybrid)
4. Lump sums from uncrystallised funds (UFPLS)
Clearly, people can also mix and match solutions and recent research showed that 41% would prefer a combination approach – showing peoples natural, yet often misguided, desire to ‘have a bit of everything’.
Within the annuity options, there are also different types and options available: Level or escalating, single or joint life, guarantees, value protection and, of course, enhanced annuities.
One area that advice can help with is the take-up of enhanced annuities. It is currently estimated that 60% of 65-year-olds in the UK could qualify for an enhanced annuity yet the actual number that benefit from increased retirement income via an enhanced annuity remains disappointingly low.
The fact that advised sales are more likely to identify an enhanced rate is no great surprise and one of the many reasons why advice should be strongly promoted for people looking to take their retirement benefits.
Some of the advice considerations of enhanced annuities, which further demonstrate the complexities and value of delivering effective retirement planning advice include:
Getting the best enhanced rate
The top 10 illnesses that result in enhanced annuities are as follows:
• High blood pressure
• High cholesterol
• Height, weight, alcohol consumption
• Heart problems
• Respiratory issues
• Neurological conditions
Clearly, the severity, nature and treatment of these conditions can vary dramatically and understanding these nuances is a far cry from financial advice knowledge and expertise. Furthermore, clients have a tendency to deny or play down medical conditions and ailments and this is clearly to their detriment where annuities are concerned.
For a relatively modest cost, you can now outsource the medical gathering part of your annuity advice process to a relevant expert to elicit the correct information. These companies offer telephone interviews with trained medical staff and have demonstrated an ability to generate higher enhancements than the industry average. This can only be good for clients and is being used more and more with continued low annuity rates available.
Recommending annuity alternatives
When considering income drawdown or many of the third way solutions, it is important for advisers to benchmark the annuity opportunity cost against the relevant rate. Therefore, if a client qualifies for an enhancement, the enhanced rate should be used.
Not only does an enhanced annuity affect drawdown (or third way) critical yields and the potential suitability of the solution but it can also make an adviser look pretty foolish if a client is to find out they would qualify for an enhancement for themselves. A potential client saying “I found an annuity paying 20% more than you said I could get” isn’t likely to win you business and long-term client relationships however unsuitable the annuity option happens to be.
Ongoing suitability of drawdown
To check ongoing suitability of drawdown, it is necessary to continue to benchmark drawdown against the relevant annuity rate. Changes in health are perhaps inevitable during retirement and it is likely that for many retirees, they will qualify for different enhancements during their retirement.
Chronic versus acute conditions
It is important to consider the differences between chronic and acute conditions, and the effect they have on annuity rates. Clients with chronic health conditions such as diabetes will qualify for an enhanced annuity but this does not necessarily mean that the client should buy one today. Because their condition is incurable they will always qualify for an enhanced rate.
However, if a client suffers an acute health condition (e.g. heart attack and some forms of cancer) they will generally qualify for a significant enhancement shortly after the incident. Thereafter, the rate of enhancement will start to recede, sometimes to the point of no enhancement whatsoever. Clients who have had an acute condition can be very focused on ‘beating the illness’ and this can create opportunities to drive a client’s retirement strategy.
You could advise the client to invest a proportion of their fund into an annuity taking advantage of the high immediate enhancement to complement their long-term strategy of beating the illness and taking advantage of the higher income available.
Furthermore, a well diversified drawdown portfolio will contain a proportion of low risk bonds/gilts. These assets are currently expensive and generating low rates of return. A high-enhanced annuity could be used to replace some of these assets at favourable rates that could allow a client to draw more income now, or increase equity exposure in the remaining fund to aim for higher growth and higher future income.
Fundamentally, more clients could benefit from annuity alternatives and/or enhanced annuities, depending on their individual circumstances. Retirement income planning is a complex area of advice and more needs to be done to educate and promote the benefits of taking financial advice – something that we can all play a part in.
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