Is it time to look again at annuities?

Annuities. For years they’ve been the Cinderella of retirement options, regarded as poor value and inflexible.
But things are changing. With interest rates rising, the cost of buying an annuity is coming down. And after the uncertainty of the pandemic years, more people are starting to think about having a secure income as part of their retirement planning.

Let’s have a good look at annuities and why you might want to think again about them.

What kind of pension have you got?

As with most other things, you need to know what kind of pension you’ve got.

Annuities are an option for defined contribution or DC pensions (as they’re commonly known), where you build up a pot of money by paying contributions (and if it’s a workplace pension, your employer pays too). You can use some or all your pot of money to buy an annuity.

If you have a defined benefit or DB pension, based on your earnings and the number of years you work for your employer, this pays you a guaranteed income for life when you retire, rather than building up a pot of money like a DC pension does.
See What type of pension do I have? for more about this.

What is an annuity?

It’s a policy that pays you an income – in other words, a pension. Annuities are sold by insurance companies. An annuity can be set up in a number of different ways to suit you and your circumstances.

The most popular are lifetime annuities that guarantee you an income for the rest of your life.
You can also get short-term or fixed-term annuities that pay out for a set length of time and may give you money back at the end.

Lifetime annuities

You get the highest amount of income by buying a lifetime annuity just for yourself, that doesn’t increase. You can get impaired life annuities that give you a higher income if you have health issues that mean you’re not expected to live as long as a healthier person.
A lot of add-ons are available for lifetime annuities, but they all make your income smaller. They include:

• taking up to a quarter of your pension savings as tax-free cash
• different types of increases, such as in line with inflation (with or without an upper limit) or fixed (at 2% or 3% a year for example)
• a pension for your partner if you die before them.

That’s just a taster – there are lots more options. And different providers offer different options, as well as different prices for annuities.

Short or fixed-term annuities

These guarantee your income for a set length of time. Short-term annuities pay for up to five years; fixed-term annuities for up to 30 years. You may get some money back at the end, and you may have to choose investments. They’re regarded as more flexible than lifetime annuities as they don’t lock you in for life, but they can be complicated.

Why did annuities become unpopular?

Poor value
Annuities used to be the only choice most people had for retirement income from a DC pension. Over the years, people grew increasingly concerned that annuities were poor value. Annuity rates – the amount of income you get for each pound of your pension savings – are linked to returns on government bonds or ‘gilts’. These returns are closely linked to what interest rates do.

From about the mid-1990s interest rates started to go down, reaching historic lows from about 2010 onwards. This meant annuity rates went down too – so the yearly amount of income you could buy got lower and lower over the years, compared to the amount of money you needed to buy it.

Inflexible
Annuities were also regarded as inflexible. Once you buy a lifetime annuity, you can’t change it. If you die shortly after buying your annuity, the whole amount you bought it with is lost – it’s not passed on to anyone else. And, although you can choose an annuity that pays a pension to a partner or dependant after you die, that income stops when they die with nothing left.

Pension freedom
As a result, when the ‘pension freedoms’ – more flexible options for retirement income – were first introduced in 2015, the number of annuities plummeted as people took advantage of the new flexibility. Lots of people took cash directly out of their pension savings. Some people went for flexible income or drawdown, where you invest your money and take income out as and when you want to. See What are my options for retiring? for more about cash and drawdown.

Why are annuities coming back into fashion?

Security
It’s estimated almost half of current retired people fear they will run out of money during their retirement. Findings by the Pensions Policy Institute and Financial Conduct Authority suggests the number of people over 75 buying an annuity has doubled over the past five years.

Becoming better value
As interest rates have risen, so have annuity rates – so annuities are starting to look like better value. In fact, they’re at their highest level for 11 years. At the end of August 2022 the buying power of pension savings worth £100,000 had increased by over 70%.

More flexible options
There are now more ways to pass your annuity money on to other people when you die. For example, value protection, where you get a smaller income in return for protecting part or all the amount of money you bought your annuity with. When you die, the amount of money you’ve received in annuity payments is taken off. The rest can be paid to beneficiaries.

You can also choose an annuity that’s guaranteed to pay out for a certain time – for example, five or 10 years – even if you die in the meantime.

Investment looks more risky
With flexible income (drawdown), your pension savings stay invested. But as recent events such as the Covid-19 pandemic and the war in Ukraine have proven, investment markets can be volatile (go up and down a lot). People may be worrying that investing their money is giving them more of a headache than it used to. In contrast, the prospect of a regular income that doesn’t depend on investment returns is looking more attractive.

Could an annuity be good for you?

As with everything else – it depends. If you’re worried about running out of money and would like some certainty about your retirement income, buying even a small annuity could give you peace of mind.

If you’ve retired and are taking flexible income, you can still use some or all your pension money to buy an annuity. Annuity rates tend to be higher the older you are, so you might get a better deal now than you could have even two or three years ago.

The Government’s MoneyHelper website has an annuity calculator you can use to see how much yearly income you could get from an annuity.

Can we help you?

Wondering where an annuity could fit into your retirement plans? Ask us for help! We love helping people get the most out of their money.

Here are a few of the reasons you might want to give us a go.

• The personal touch. We go out of our way to understand you, your life situation, and what you want.
• We really know our stuff. We’ve got over 50 years’ experience of helping people plan and achieve the retirement they want.
• We’re completely independent and unbiased. 
• Your first consultation is on us.

We can help you plan the retirement you want, so you can get on with enjoying life without having to worry about money – now or in the future.