Ask people what they’d like from their pension in retirement and you’ll likely find that most want at least some element of guaranteed income. Yet the product that’s designed to provide exactly that has been largely ignored over the past decade.
Annuities were previously used by the vast majority of retirees to convert their pension pot into a regular retirement income. But sales collapsed when pension reforms in 2015 gave people much greater flexibility in how they accessed and used their pension savings. Just one in ten of the pension pots accessed for the first time in 2023/24 were used to buy an annuity, according to the Financial Conduct Authority (FCA).
Sales have rebounded over the past couple of years – rising 20% in 2024, according to the Association of British Insurers – as a combination of higher gilt yields and higher interest rates has taken the income paid by annuities close to record highs.
Yet many retirees continue to overlook them. There are some historic reasons for this. The FCA had warned in 2014 that the annuities market was “not working well for consumers”, while rates had been in a long-term decline. But with annuities still having an important role to play in retirement finances, we offer a reminder of a few things you should know about them.
They can be good value – if you shop around
Your pension provider will offer you its own annuity deal as you approach retirement, but this is unlikely to be the best value available. It’s important to search the market for the best deal, because there’s a big gap between the highest and lowest rates available.
A 75-year old man buying an annuity could get almost 20% more income by choosing the best deal over the worst, according to research by Just Group of latest rates reveals. This amounts to £7,400 more income over 10 years from a £50,000 pension pot. The difference for a 65-year old with a £50,000 pension is 13%, equating to £4,380 more income over a decade.
The big names in the market include the likes of Standard Life, Aviva, Scottish Widows and L&G. Your best bet is to compare different options through services such as MoneyHelper, Hargreaves Lansdown and Age Partnership, and/or use a professional annuity broker or financial adviser to help you get the right annuity for you.
There are different types available
Finding the best deal also involves identifying the type of annuity you want, because your choice can make a big difference to the income you can get. The most popular is the level annuity, which pays out the same income each year for the rest of your life.
An alternative is an inflation-linked annuity, which starts at a lower level but rises each year in line with the retail prices index (RPI). Similarly, an escalating annuity starts off with a lower rate than from a level annuity, but increases by a fixed rate each year.
Another option is a short-term or fixed-term annuity, which pays a guaranteed income for a set period of time (usually between five and 10 years, with the option to then buy a lifetime annuity when the term ends). If you have a lifestyle or health conditions that affect your longevity, you could consider an enhanced or ‘impaired life’ annuity. This provides a higher income on the assumption that it won’t need to pay out for as long.
Some people will also need to decide between a single or a joint life annuity. The latter covers your spouse, civil partner or another dependent in the event of your death, paying out a pre-agreed proportion of the income you had been receiving.
They offer protection against market volatility
The most obvious advantage of annuities is that the income they pay is guaranteed for as long as you need it. This means that unlike the money held in drawdown pots, ISAs or any other asset, the income it provides isn’t affected by the ups and downs of investment markets.
As more retired investors become aware of the risks around drawdown and experience the effects of market volatility on their pension savings, the security and guarantees provided by annuities becomes even more valuable.
They’re good for your wellbeing
One of the big advantages of annuities is the peace of mind provided by the security of a reliable income. So it’s no surprise that a recent study by Legal & General and the Happiness Research Institute found that retirees who had taken out annuity reported lower levels of stress, greater life satisfaction and higher levels of financial confidence than those without an annuity.
The research also revealed that annuity holders were 40% more likely to consistently afford their credit card payments or loans compared to those who hadn’t taken one out.
They can be part of the solution
Some retirees previously objected to annuities because they resented having to make an irreversible decision that tied their pension savings up in one product (especially when rates were falling). Now, however, there’s no need to use all your pension savings to buy an annuity.
For many people it makes sense to take a blended approach so they get the best of both worlds – potential for growth with an element of security. There are several different ways of doing this. For instance, you could use some of your pension pot to buy an annuity and leave the rest in a drawdown arrangement, or you could initially leave all your pension in drawdown but earmark a proportion of it to buy an annuity at a later date. Some providers also have specific ‘managed retirement’ options
As always, there are factors such as tax, individual circumstances and financial objectives to consider, so it’s well worth taking professional advice if you can.
Photo by zimmytws’s images on Canva
