This an article I wrote for Professional Adviser and Retirement Planner - read the original article here

The Chinese may be celebrating the dawn of the Year of the Rooster this weekend, writes William Burrows, but could 2017 also see UK advisers and their clients celebrating the return of annuities as a viable alternative to pension drawdown?

If 2017 truly is to be the year of the annuity, several things need to happen. First of all, bond yields must rise significantly. Second, advisers and their clients need to be convinced there is a role for annuities now there is freedom and choice. In addition we need to have a better understanding of the various behavioural and technical factors that impact the decision whether to arrange an annuity or invest in drawdown.

I cannot predict how bond yields will move as the realities of Brexit and Trumponomics work their way through the economic system, but one possible scenario is that interest rates and inflation will rise in the UK (and the US) pushing bond yields upwards.

There is a simple rule of thumb – every 100 basis-point change in the underlying annuity yield results in annuity income increasing or decreasing by about 8%. I follow the 15-year gilt indices published in the Financial Times and currently it is 1.89%. This means that if the yield increased to, say, 2.5% during the year we could expect annuity incomes to rise by about 5%.

The benchmark annuity rate – £ 100,000 joint life annuity for ages 65 and 60 in good health, with two-thirds partner’s pension and level payments – currently pays £ 4,432 per annum. Those who smoke, take prescription medication or have a medical condition may qualify for a higher annuity but this is not ‘free money’ – it is only accelerating the return of the original capital to reflect reduced life expectancy.

It is easy to make a comparison with the 4% drawdown rule and conclude there is no point in purchasing an annuity when the amount of sustainable (level) income is similar from both options. This can be misleading, however, because an annuity is return of capital and interest and the annuity income stops on second death, whereas drawdown provides a lump-sum death benefit. On the other hand, the annuity is truly sustainable in that it is guaranteed for life whereas drawdown is not normally guaranteed.

A viable alternative?

This begs the question – at what levels do annuities become a viable alternative to drawdown? The short answer – and this is a pure guess based on my intuition and experience – is that if the benchmark yield increases to 2.5% we could see the benchmark annuity get close to the £ 5,000 mark and risk averse investors will find the returns from annuities more acceptable.

The easiest way to see this is to look at my annuity charts at Retirement IQ but you will notice from the following chart that the benchmark annuity was paying close to £ 5,000 in July 2015 when the yield was around 2.5%. We need to go back to October 2013 to see the benchmark yield above 3% and annuity income nudge towards the £5,000 level.

See latest chart

Now, you may of course reasonably point out that an extra £500 a year before tax does not buy much and yet it is not just a question income – it is also about risk.

A longer answer – and this requires advisers and their clients to be convinced there is a role for annuities alongside drawdown – is that, as we travel through more uncertain times, behaviourally and technically the case for annuities becomes stronger.

Behaviourally, people place a higher premium on peace of mind and security as they grow older, especially if they are concerned about world events. Technically, as people grow older, the benefits from mortality cross-subsidy increase and the break-even rate between annuities and drawdown changes in favour of annuities.

There is still a long way to go before we can argue annuities are such good value they are a 100% replacement for drawdown. We are, however, close to the time where we can argue most people should have some annuities as part of a risk-averse portfolio of retirement income options.