"The yield performance of annuities, especially against an independently calculated sustainable withdrawal rate, serves as an important reminder that they continue to offer a valuable option for investors"
The IRESS Relative Annuity Yield Index compares the income yield of annuities to cash ISA rates, an example of a UK Equity Income fund and a sustainable withdrawal rate.
The comparison between annuity yields and UK Equity Income is calculated based on the average 12-month yield for the UK Equity Income Fund less the average annuity rate for that year (a number around zero or less indicates that annuities have outperformed).
The comparison between annuity yields and cash ISA rates are calculated by taking the annuity yield, minus the average cash ISA rate for the 12-month period.
For the third measure in the index - annuity yield vs. sustainable withdrawal rate - IRESS required a representative portfolio that someone retiring might reasonably hold – 40% invested in equities, with the rest in bonds and cash. It also required a withdrawal or income rate which offers a reasonable chance of success in terms of it lasting 25 years, which is a realistic expectation for someone retiring in their mid-60s (remembering that enhanced annuities can offer far better rates than standard ones).
For its index, IRESS has chosen Morningstar’s estimated 4.5% as the sustainable withdrawal rate that fits the required 40% exposure to equities with a 50/50 chance of success, taken over 25 years.
This sustainable withdrawal rate is only slightly below the current annuity rate of 4.83%. But with a probability of success at 50%, this means there is as good a chance of failure as success (ie having some of the fund left after 25 years).
The comparison of annuities against a fair sustainable withdrawal rate illustrates that the trade-off between certainty of a predictable income for life and a portfolio that has as good a chance of failure as success is actually quite small.
IRESS – UK managing director Simon Badley, said: “The yield performance of annuities, especially against an independently calculated sustainable withdrawal rate, serves as an important reminder that they continue to offer a valuable option for investors looking for absolute certainty in retirement.
“It’s true that the negative commentary and falling rates over the years may have made annuities appear less attractive in comparison to other options for retirement income, but industry opinion suggests a plateau has now been reached. It now appears that the retirement market is readjusting to a new normal following the dramatic swings in the wake of the pension freedoms. The relative value of annuities assessed against other retirement income options deserves a fair hearing and we hope the IRESS Relative Annuity Yield Index helps deliver a new context for comparison.”
