Investment-linked annuities - a flexible approach

Andrew Tully explains how, by offering a flexible income similar to income drawdown, investment-linked annuities could be ideal for older clients.

Source: Investment Life & Pensions Moneyfacts

Income drawdown has had a tough couple of years, with sales falling and regular negative media coverage. But, helped by the Government’s decision to reverse income to the old 120% level, reasonably healthy investment markets and low annuity rates, the outlook is more positive. And that’s good as drawdown is a valuable tool for advisers and clients.

But while drawdown is suitable in some situations it does have weaknesses. A key one being the increasing risk capped drawdown customers face as they move through their 70s.

So it’s important people consider when and how they will leave drawdown. And that’s where investment-linked annuities can be very useful. They allow people to maintain the investment exposure and income flexibility they have been used to, while also taking declining health into account and reducing risk by benefiting from the cross subsidy available within an annuity. Investment-linked annuities offer people a flexible changeable income, in a similar way to drawdown. Maximum income for a healthy individual is broadly similar to drawdown.

But annuities can also take health and lifestyle into account, which means the many people whose health deteriorates during their time in drawdown can get a significantly higher income from an investment-linked annuity.

In addition, one of the key benefits of an annuity, mortality cross-subsidy, has an increasing importance as people grow older. On death any remaining fund - after death benefits are paid - is pooled for the benefit of other annuitants. This is the reason why annuities can pay out a guaranteed income even when someone lives beyond their expected lifespan.

With investment-linked annuities the benefits of the mortality cross-subsidy are built into the product as yearly bonuses, and this allows customers to reduce their dependency on investment returns. For example, if we assume an income drawdown customer would  need a 6% yearly investment return to maintain their income, an investment-linked annuity would only need a return of around 4% for someone who entered the contract at 70 and lived to 85. For someone entering at 75 and living to 90 the difference is even more stark, with only a 2.5% investment return required – as the cross-subsidy ‘makes up’ the difference (i).

Income drawdown can be hugely beneficial for some clients. But it is unlikely to be a suitable contract for the majority of older customers. An investment-linked annuity can offer much of the same flexibility as drawdown while also offering a higher maximum income to the many who are suffering from some impairment. And, crucially, the benefit of cross-subsidy can greatly reduce the investment risk for these older clients.

 (i) Calculations by MGM Advantage. Income taken 100% of GAD tables, same charges for both contracts. For professional advisers only.

The full article is available in the September edition of  Investment Life & Pensions Moneyfacts.