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.