Annuity rates have hit a 14-year high, offering pensioners who convert their pension pots into annuities thousands of pounds of extra income. With rates hitting their highest level in 14 years, is it time to buy an annuity?
Rates have risen 52% this year, thanks to soaring gilt yields, which have been boosted by the Bank of England’s interest rate hike. The last time annuity rates reached this level was during the 2007-2008 banking crisis.
In January, the yield on 15-year gilts was around 1.15%. It reached 3.5% in mid-September, and after the mini-budget it climbed to almost 5%, before the Bank’s emergency purchases pushed it back.
The steep rise in annuity rates means that a 65-year-old with a pension pot worth £100,000 who buys an annuity would now receive a guaranteed income of £6,873 a year, according to pension provider Canada Life. This compares to someone who bought an annuity at the start of 2022, who would only receive an annual income of £4,521.
The break-even point – the point at which you would receive your initial pension through income – has also been reduced by seven years, from 22 years to 15 years.
We take a look at how annuities work and if it’s time to buy one.
Why are annuity rates increasing?
Annuity rates are tied to government bond yields, which have soared this year, especially since last month’s “mini budget”. It’s arguably a silver lining to both homeowners and first-time buyers worrying about mortgage rates and where investors have seen huge turbulence in the markets that has impacted their portfolios.
Annuities were previously unpopular with retirees, with only 10% of retirement savings used to buy an annuity in the 2020-2021 tax year. Direct debit is generally considered more flexible and better value for the most part.
But experts say annuities could be set to return after rates rise, which could give retirees a boost in income. Annuities are an attractive option for those who prefer the guaranteed income security they provide.
Is an annuity the right option for me?
If you decide to buy an annuity, it should be noted that this decision is irreversible and therefore it is important to think carefully about the pros and cons of buying an annuity.
Here are some things to consider:
- You don’t have to use all of your retirement capital to purchase an annuity. You can use part of your pension and access the rest of the money via direct debit, which can give you more flexibility in how you earn income from your pool.
- You can choose at what age to buy one. You may prefer to use the drawdown to start and buy an annuity later. It should be noted that the older you are, the better the annuity rate.
- You can continue to contribute to your pension fund after purchasing an annuity. But remember that the usual tax rules apply; most savers can contribute up to £40,000 per tax year (known as the annual allowance) and receive tax relief.
- Annuity income is taxable, so it may impact any potential income tax bill.
- Don’t just accept the annuity rate offered to you by your pension fund – always look for the best rate. Use the government-backed MoneyHelper service’s free annuity comparison tool to help you find the best rate.
- If you’re unsure of your options, talk to a financial advisor or annuity broker first. A wrong decision could end up costing you dearly.
Nick Flynn, Director of Retirement Income at Canada Life Retirement Company, comments, “Clients planning for retirement or looking to de-risk their investment portfolios should review annuities.
What is an annuity?
An annuity is an insurance product that pays a guaranteed income for life in exchange for your retirement pool.
When you retire, you can choose to exchange your nest egg for an annuity, or keep the pension as it is and withdraw money when you need it – this is called withdrawal.
There are different types of annuities:
- an enhanced annuity – this pays a higher amount if you are sick or smoke, factors which the insurer says will affect your life expectancy
- an indexed annuity – this is linked to inflation
- A “joint and survivor” annuity – this pays income to a spouse when you die.
- term annuities – pay income for a fixed period, say ten years, rather than for your lifetime.