Return needed to beat an annuity halves in four years

The returns needed for a drawdown pot to beat an annuity have almost halved in the last four years, a Corporate Adviser investigation can reveal.

A 60-year-old investor withdrawing what a level annuity would pay each year currently needs a net investment return of just 2.4 per cent to be able to buy an equivalent annuity a year later, based on rates at March 2015. That compares with a return of 4.4 per cent that was required to preserve annuity purchasing power in June 2011, according to figures from Retirement Intelligence/William Burrows Annuities.

Burrows graph
Burrows graph

The fall in hurdle rates has mirrored falling gilt yields. At the end of June 2011 15-year gilt rates stood at 3.98 per cent, but have fallen to 1.97 per cent today.

For healthy individuals not entitled to an enhanced annuity, the hurdle rate their drawdown pot needs to beat to be better off without an annuity only reaches 4 per cent at age 77, rising to 4.9 per cent by age 80.

In June 2011, a 77-year-old needed a net return of 6.4 per cent to preserve annuity purchasing power, rising to 7.6 per cent by age 80.

The hurdle rate is higher for individuals entitled to enhanced annuities, rising from 3 per cent at age 60 to over 9 per cent by age 80.

Retirement Intelligence director Billy Burrows says: “What we have here is a risk paradox where people think they are taking no risk by buying an annuity, but there is a risk they are missing out on doing better by staying in drawdown in their 60s if they are in good health.

“These mortality figures reflect the situation in the market today. Pricing is going to change in the future as insurers factor in consumer behavior, particularly the effect of people being more likely to buy an annuity if they have good life expectancy prospects. This could see mortality factors reducing over time, especially if insurers start writing 25 year guarantees.”

Aviva head of policy John Lawson says: “The fact that this hurdle rate has come down so much since four years ago means markets are effectively saying to people that they should take more risk at present.”