Pensioners get £2,250 extra income from annuities but rates are about to peak

Martin Lewis compares pension annuity against drawdown

Annuities pay a guaranteed income for life no matter how long you live, giving security in your old age. However, may see them as inflexible and poor value, because you have to hand over all of your capital.

Sales plummeted after 2015’s pension freedom reforms scrapped the obligation to buy an annuity, with most pensioners now leaving their retirement savings invested via drawdown and taking lump sums and income as required.

Yet annuities are in demand again as the income they pay has jumped almost 50 percent since the Bank of England started hiking interest rates in December 2021, with £1billion sold this year, according to the Association of British Insurers.

Ed Monk, associate director at Fidelity International, said annuity rates are largely based on Bank of England gilt yields, which have hit their highest levels since 2008.

Today, 15-year gilts yield 4.46 percent and could climb higher with the BoE expected to hike base rates for the 14th meeting in a row on August 3.

This may push gilt yields even higher for a while, but they’ll fall back when the BoE stops hiking, Monk said. “That means current prices could represent a peak.”

If he’s right now could be the perfect time to lock into an annuity income at rates, yet it’s a complicated decision.

Today, a 65-year-old with £100,000 pension can get annuity income of up to £7,264 a year. Just two years ago, the same person would have got less than £5,000.

That’s a huge difference. It means they get more than £2,250 extra income every year, worth around £45,000 in total over the average 20-year retirement.

It’s not hard to see why sales are surging.

Older annuity purchasers can get even more as their life expectancy is lower, said Helen Morrissey, head of retirement analysis at Hargreaves Lansdown. “A 70-year-old with £100,000 can now get up to £8,141 a year. Smokers and those with illnesses may qualify for an enhanced annuity, giving their income a further boost.”

Annuities aren’t for everyone and potential buyers should ask themselves five key questions.

1. How high will rates go? The BoE is still expected to hike interest rates two or three more times, even though inflation fell in June.

Buyers could get a slightly more income if they wait, but there is no certainty of that. Once markets expect interest rates to peak and fall, annuity rates could slide also.

Timing your purchase is almost impossible, Morrissey said. “Instead, it could make sense to annuitise your pension in tranches throughout retirement rather than in one transaction.”

2. Single or joint life? Most people take out a single life annuity where the income dies with them. However, couples should consider a joint life annuity, where the surviving partner gets 50 percent of ongoing income. 

Also decide whether you want a level income or one that rises with prices. It’s not an easy decision. An inflation-linked annuity will pay notably less at first, and it can take up to 15 years to break even overall.

3. Have I got the best deal? Too many annuity buyers simply take what’s on offer from their pension company but that can be costly as rates can vary dramatically, said Stephen Lowe, group communications director at Just Group.

“The most competitive provider can deliver nearly 18 percent more income. It means you could get an extra £1,000 a year by shopping around. That’s every year for life.”

Always compare rates, known as “taking the open market option”, from the main providers Aviva, Canada Life, Just Group, L&G and Scottish Widows.

4. Have I declared all illnesses? Annuity buyers with health issues or poor lifestyle habits such as smoking actually benefit when they buy an annuity, by getting more income as there life expectancy is lower.

Damon Hopkins, head of DC workplace savings at independent consultancy Broadstone, said it’s in your interest to disclose all medical and lifestyle issues. “This can make your hard-earned savings work a lot harder by giving you a higher rate of income.”

5. What about my beneficiaries? While unused pension can be passed on to loved ones free of inheritance tax, annuities typically die with you (though some plans include an option to return unused funds).

Dean Moore, head of wealth planning for RBC Wealth Management, suggested a mix-and-match approach. “Maybe use part of your pension pot to create a guaranteed income stream to reduce risk, with the reminder used more flexibly.”

These are all complicated decisions, so think things through and consider taking independent financial advice. Ideally before annuity rates peak, rather than afterwards when you’ll get less.

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