Extra income for life
ANNUITIES have swung back into fashion as higher interest rates mean they pay pensioners thousands of pounds more income every year, but the impact may soon fade as the Bank of England gears up to cut interest rates.
An annuity is the guaranteed lifetime income that retirees can buy with their pension savings, and until 2015 they were legally obliged to do so.
Sales collapsed overnight once that obligation was withdrawn under pension freedom reforms, as retirees rebelled against restrictive, poor-value annuities.
Most now choose to leave their money invested via drawdown, which allows them to benefit from stock market growth and the flexibility to withdraw lump sums as required.
Drawdown has many benefits but there is also a danger of depleting your pot, something that will not happen with an annuity, as the income is guaranteed for life, no matter how long you live.
At the start of 2022, before inflation took off like a rocket, a 65-year-old buying an annuity with £100,000 got income of as little as £4,540 a year, said Nick Flynn, retirement income director at Canada Life. “Roll the clock forward two years and that same annuity pays around £7,000 a year, an increase of 54 per cent, driven by rising interest rates and the returns available on gilts.”
Over a 20-year retirement, today’s
annuities deliver around £49,200 extra income compared to an annuity sold in January 2022, Flynn added.
Demand has rocketed as a result, with provider Canada Life selling £1.2billion worth in a year, and sales across the market rising 43 per cent in 2023, according to the Association of British Insurers. Flynn said: “The annuity market is incredibly busy, with pensioners seeking retirement income security.”
The great annuity rate rebound will infuriate those who locked in before interest rates started to recover, as they are unable to exchange their policy for one paying higher income.
Annuity rates are closely linked to the yields on UK government bonds, known as gilts, which are in turn affected by the Bank of England base rate.
The BOE has held the base rate steady at 5.25 per cent for the past seven months, but with inflation falling, markets expect the first cut in May or June.
At that point, annuity rates may start to fall too. In fact, they could fall before the first cut comes through, as markets anticipate the change.
The process may have started, with the Standard Life Annuity Rates Tracker showing that a 65-year-old with a £100,000 pension pot can expect income of £6,890 a year, rather than £7,000. However, that is still £440 more than a year ago, a rise of 6.89 per cent.
Pete Cowell, head of annuities at Standard Life, said pensioners prize annuities for the certainty of income they offer, but said it does not have to be a “one-and-done” approach.
Annuities pay more as you get older and your life expectancy shrinks, so it can make sense to use a chunk of your pension to buy an annuity today, while keeping money in reserve to buy another later.
Buyers have to choose between a level income, which pays more today but will never increase, or an escalating one that rises with prices but from a lower starting point.
Andrew Tully, technical services director at Nucleus Financial, said for those who are unsure whether to buy an annuity, there is a halfway house.
“You could split your pension between an annuity and drawdown, giving the best of both worlds.”
If tempted, do not wait too long.there is a chance that in a few months time, annuities could pay just that little bit less than they do today.