The facts!

Due to the Bank of England's several base interest rates increases this year, annuity income has continued to rise. According to separate figures from the Association of British Insurers (ABI), sales of annuities increased by 22% during the first three months of 2023, reaching their highest level since 2014.

The current cost of borrowing is at 5.25% after the Bank of England raised interest rates for the fourteenth consecutive month in August. In comparison with December 2021's 0.25% base interest rate, rates have increased vastly.

What these increases mean

The increases mean a 65-year-old with a pension valued at £100,000 might receive an annuity income of £7,358 a year. Two years ago, the same pension fund would have only purchased an annuity of £4,946 because, since 2021, annuity rates have increased by circa 50%.

What is an annuity?

An annuity converts your savings into an annual pension. If you’ve put money into a pension scheme during your working life, you’ll have to decide what to do with the pension fund you’ve built up when you approach retirement age.

The annuity rate is determined by things like interest rates and competition among insurers, and of course, whether you get a good deal will depend on your individual circumstances and how long you live.

Annuities offer a guaranteed stream of income, which can provide peace of mind for retirees and other investors seeking to ensure a stable source of income in their later years, and the option to leave money to your beneficiaries. Some annuities may also be optimised to help pay for long-term care.

What are the different types of annuities?

Level annuities- A level annuity will pay you the same income each year. They have a higher starting income than an escalating annuity, but they can leave you vulnerable to inflation, which might make your annuity income worth less over time. Even low levels of inflation can significantly reduce your standard of living.

Escalating annuities- An inflation-linked annuity will rise each year in line with the retail price index. This protects your annuity against inflation, but it will start at a much lower rate. You'll need to consider your particular circumstances, such as your health, whether you want to receive an annuity income over a short or long term, and whether you want to leave an income to a spouse or partner after your death.

Impaired or enhanced annuities- These pay out a higher income if your health or lifestyle may shorten your lifespan – for example, if you have an existing health condition or you smoke or are overweight. It's important to make sure that any provider you speak to asks you about your health so they can properly consider whether you're eligible for an impaired or enhanced annuity, as the income rates may be considerably better than other types of annuities.

Lifetime annuities- These will pay you an income for the rest of your life, unlike a short-term or fixed-term annuity.

Joint life annuities- These will pay an income to your spouse or partner after your death, but this is usually at a lower rate.

Short-term or fixed-term annuities- You can use part of your pension pot to buy an annuity that provides a short-term income. The rest of your pot is left invested, and you can still choose to buy a lifetime annuity when your short-term one expires. You might choose a short-term annuity if you don’t want to commit your pension fund to a life annuity as you believe rates might get better in the future.

You can customise an annuity to fit your needs, but you'll usually have to pay more or accept a lower monthly income.

Pros to pension annuities

Annuities provide peace of mind- You could get a guaranteed, regular income for life, whatever happens to the stock market and even if you sail past your 100th birthday.

Plus, with an annuity, you just make the one decision and then it’s done, so no worrying about investments in the years ahead.

The rate can rise with inflation- If you’re willing to start off with a lower income, you could choose an annuity that rises with inflation.

A joint annuity will pay your other half an income if you die first- These pay a lower rate to you when you’re alive than a “single-life annuity”, but also provide a spouse or civil partner with an income after you pass away.

It pays a higher rate if you have a shorter life expectancy-If you have an underlying health condition, you could get an enhanced rate.

Cons to pension annuities

You can’t get a refund- There’s no way of changing your mind later and you can’t alter the amount of income you receive each year.

Poor death benefits- If you were to die the day after you take out a single-life annuity, the insurer would retain all the money. This means there wouldn’t be anything left of your pension to leave to your loved ones.

Is an annuity right for me?

It’s crucial to carefully weigh the advantages and disadvantages of purchasing an annuity before making a decision as you can not change your mind later. Consider paying for expert advice from an independent financial adviser – it could be the best money you ever spend.

If you’re unsure or would like to discuss your options further, get in touch with one of our advisors here.

Disclaimers: A pension is a long-term investment. The fund’s value may fluctuate and can go down. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.