An Annuity is a serious business!

“An annuity is a very serious business; it comes over and over every year, and there is no getting rid of it”, wrote Jane Austen in Sense and Sensibility in 1811.

Annuities are still a serious business today because they are the only financial product that can provide a safe and secure lifetime income for retired investors.

What is an annuity?

An Annuity is an investment that guarantees to pay a secure income for the rest of your life, no matter how long you live.

In the UK there are basically two types of annuities; pension annuities (compulsory purchase) and purchased life annuities (voluntary purchase). All annuities share the following characteristics:

• An annuity is an investment which pays a high income for the rest of your life.
• When you buy an annuity you are turning a lump sum into a stream of future income.
• Lifetime annuities guarantee to pay an income for as long as you are alive, no matter how long you live.
• When you die, payments stop, unless you have chosen a joint life annuity or a guaranteed payment period

Annuities = income for life

The advantages of Annuities

• Annuities are the only policy which guarantees income for life. (No matter how long you live)
• They provide a high level of guaranteed income
• They are simple to understand and give security and peace of mind
• Annuities are based on the concept of "mortality cross subsidy so they insure you against out living your assets

Short history of annuities - Starting with the Romans

Annuities are one of the oldest financial contracts and their origins can be traced back to Roman times, when policies known as annua promised to pay income for a fixed term, or possibly for life.

Annuities were available in the Middle Ages, the most famous of which were known as tontines. These policies paid an income for life, and every year the payouts for those who died were spread amongst the survivors. The last surviving policyholder received the remaining capital. Thus they combined the concept of insurance with an element of gambling.

The last surviving policyholder received the remaining capital. Thus they combined the concept of insurance with an element of gambling. During the 1700's several governments including England and Holland sold annuities in lieu of government bonds. Today they play a very important part in retirement planning, and last year the annuity market was over £6 billion

During the 1700's several governments including England and Holland sold annuities in lieu of governments bonds. In the 19th century annuities were used to provide income for elderly relatives or employees.

Annuities and Pensions

However it was not until the introduction of self employed pensions nearly 30 years ago that annuities started to play an important role in the UK pensions market. The early self employed pension plans (s226 contracts) were in fact deferred annuity policies i.e. investors saved up for an income, but this income was secured by way of an annuity. Most contracts contained an open market option, which gave the investors the right to buy a better annuity from another company.

Personal Pensions were introduced in 1988 and required that an annuity had to be purchased to secure retirement income, and all these contracts contain an open market option. Pension drawdown was introduced in 1995 and this allowed the annuity purchase to be deferred until age 75, but in the meantime an income could be drawn from the pension fund.

Investment linked annuities

Annuities that invest in the stockmarket, commonly known as Investment Linked Annuities, have been available for some time. Commercial Union, and Provident Mutual were amongst the first to offer these, followed by Equitable Life, Prudential and Scottish Widows. In August 1999, Norwich Union and Sun Life introduced with profits annuities, and it is expected that more companies will launch with profit annuities as this option becomes increasingly more popular.

The market in the 21st century

In 2008 it was estimated that over £11 billion of pension annuities were purchased, of which about 83% were non profit and RPI annuities, 12% were enhanced annuities and the remaining 5% being investment linked annuities. The annuity market is growing at about 10% per annum, and the share of with enhanced annuities is increasing is growing rapidly. Over £2 billion was invested in drawdown.