As rates rise is an annuity now a safe option to invest in again?

FEW mourned the demise of annuities, which fell out of favour after the Government abolished the obligation to buy one with your pension at retirement in April 2015. Yet they are now heading for a shock revival.

Rising interest rates have driven up annuity rates, while volatile stock markets have increased the risks of leaving pension funds invested via drawdown after retirement.

So is buying an annuity something pensioners should consider again?

FRUSTRATION AND FURY

An annuity is the guaranteed income that you buy with your pension at retirement, which can either last for a set time period or for life.

People hated them as they are restrictive, because once you have taken one out you cannot change or amend it.also, if you die shortly afterwards, the annuity income dies with you, unless you took out a joint life annuity with your partner.

Frustration turned to fury when annuity rates collapsed in the aftermath of the financial crisis, so that a 65-year-old with £100,000 of pension pot might get level annuity income of just £4,500 or so a year, even less if they wanted it to grow with inflation.that is a dismal return from a lifetime of saving.

Sales collapsed from around 360,000 a year to just 60,000. Companies abandoned the annuity market leaving just a handful today – Aviva, Canada Life, Just Group, L&G and Scottishwidows.

DRAWDOWN UPSIDE

Most retirees now prefer to pocket their 25 per cent tax-free cash then leave the rest of their pension invested via drawdown, taking regular income or lump sums.that way their retirement savings continue to benefit from share price growth, for the remaining 20 or so years of their retirement. The downside is that drawdown also exposes pensioners to stock market volatility, and a potential pensioncrushing crash.

It was a risk many were willing to take.almost 600,000 people aged 55 and over now make flexible pension withdrawals via drawdown every year, which is 10 times the number buying annuities.yet now the balance is shifting back in favour of annuities.

INTERESTING TIMES

The Bank of England has increased interest rates three times, albeit to just 0.75 per cent, and this has pushed up annuity rates.

Today, a single man aged 65 with £100,000 can get level annuity income of £5,454 a year, almost £1,000 more than in the post-financial crisis days, according to latest figures from Hargreaves Lansdown.that is not riches but it is a lot better than it was.

If interest rates continue to climb, annuity rates will inevitably follow, said Andrew Tully, technical director at Canada Life.this will only benefit pensioners buying annuities in future.

“Millions of existing annuity holders cannot take advantage as they are locked in for life,” he said.

Many older pensioners who were compelled to buy poor value annuities are naturally resentful.

DOING THE SUMS

Today’s annuity buyers are getting a better return than they were, said Interactive Investor’s head of savings and pensions Becky O’connor: “If you can get £1,000 extra income a year that could add up to an extra £20,000 in total over the course of a 20-year retirement.”

At the same time, drawdown dangers have emerged.the big worry is that the over-55s will draw too much money in the early years of retirement, and run out later.

There are signs this is happening.a rule of thumb states that if you draw four percent of your pension pot each year as income, it will never run out.

Last year, almost half the people in drawdown took more than 8 per cent of their pension instead.that is double the safe withdrawal rate.also, drawdown has yet to be tested by a full-blown stock market crash since it became popular in 2015.

When shares crashed at the start of the pandemic in March 2020, central bankers raced to the rescue, flooding markets with stimulus.they may not do so in the next crash, leaving drawdown savers vulnerable. Yet income from an annuity income would continue unaffected.

Stephen Lowe, pensions expert at Just Group, said both options have pros and cons: “Annuities pay lower income, but it will never run out. Drawdown helps your pension grow, but a crash could wipe it out.”

‘You could leave most of your pension invested via drawdown but use a chunk to buy an annuity’

FINE BALANCE

The decision will come down to your circumstances and attitude to risk.

It all may also depend on whether you have children – funds in drawdown can be passed on when you die, annuity income cannot.

Alternatively, there is a halfway house.tully said: “You could leave most of your pension invested via drawdown, allowing it to grow, but use a chunk to buy an annuity.”

As you get older, you may not want the risk and trouble of managing your own pension funds via drawdown. “Instead, you could steadily lock more of your money into an annuity, while generating a higher income as you get older,” he said.

That option will appeal to some, but many want nothing to do with annuities. Once bitten, twice shy.

Drawdown will continue to appeal to most pensioners, just remember that it has risks as well as rewards.