If you are a retiree looking to buy a guaranteed income in retirement, it might make sense to buy an annuity sooner rather than later. Annuity rates are expected to fall later this year once interest rates are cut.
Until recently, annuities had fallen out of fashion thanks to poor rates. The amount of income you can earn from an annuity is linked to government bond yields.
In the aftermath of the global financial crisis, the world lived through an ultra-low-yield environment. However, bond yields have risen significantly in the aftermath of the pandemic thanks to higher interest rates.
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The Bank of England hiked the base rate 14 times between November 2021 and August 2023, and has been holding it at a 16-year high of 5.25% for almost a year.
Annuity rates also skyrocketed in the aftermath of the mini-Budget in 2022, when government bond yields spiked in response to Liz Truss’s intended tax cuts.
At this time, a 65-year-old with a £100,000 pension could get up to £7,586 per year from a single life level annuity with a five-year guarantee, according to Hargreaves Lansdown. This was 52% more than they could have got in July 2021 (£4,979).
Annuity rates are slightly lower today than they were immediately after the mini-Budget, but the same person could still get up to £7,217 per year. But how much longer will these rates last?
Will annuity rates fall?
Annuity sales had a great year in 2023, according to the Association of British Insurers. The number of annuity contracts sold was 72,200 – a 34% increase compared to 2022 – as retirees looked to take advantage of higher rates.
However, those looking to lock in a decent retirement income may need to act quickly.
“After years of riding high, there are signs that these rates may not be around for much longer, as rumours swirl that the Bank of England is looking to cut interest rates in the coming months,” says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.
Inflation is now back to 2% and, if key economic indicators like services inflation and wage growth continue to slow, the Bank of England could make its first cut this summer.
Reuters recently polled a group of economists, and 63 out of 65 said they thought August was the most likely month for a first rate cut. Only two disagreed, opting instead for September. On top of this, “most of them expect at least one more reduction this year,” the news agency added.
The good news for those weighing up the pros and cons of an annuity is that the Bank of England is likely to cut rates gradually. This means annuities “will continue to offer good value for some time yet”, as Morrissey points out.
That said, it still makes sense to give it some thought now before rates start to come down.
Is an annuity right for me?
Just because rates are good right now, that doesn’t necessarily mean an annuity is the right retirement strategy for you.
Using your pension pot to buy an annuity is an irreversible decision, so you need to think carefully before making your mind up and should seek financial advice if you are unsure. You can find an independent adviser at Unbiased or VouchedFor.
Some people may prefer to keep their pension pot in drawdown. This is when you keep part of your pot invested (where it will hopefully continue to grow), while withdrawing cash flexibly as and when you need it.
Others may prefer to do a combination of the two approaches. You could use part of your pot to buy a guaranteed income, while leaving the rest invested so that you can draw on it as and when you need.
It’s also worth mentioning that there are different types of annuities on the market. Some are linked to inflation, while others pay a fixed amount out each year.
Likewise, some annuities continue to pay an income to a beneficiary (such as a spouse or civil partner) after you die, while others do not.
Shop around to secure the best rate
As well as considering what type of annuity is right for you (if any), you should do your homework to ensure you get the best rate.
“There are several providers on the market and they all price differently so if you just accept the first quote then you may be missing out,” Morrissey says. Using a comparison site is a good starting point, she adds, but reminds retirees that there’s more to consider than the annual income alone.
“Single life annuities offer higher incomes than joint life ones but the joint life one will offer an income to your spouse should you die first,” she points out.
Similarly, an inflation-linked annuity will generally offer a lower starting income than a level annuity, but if you live long enough (and inflation is high), you might end up getting more from the inflation-linked product.
We looked at the figures in a recent piece: “Is it worth taking out an inflation-linked annuity?”
Finally, Morrissey recommends giving all of your health details – including whether you smoke or drink – as this information feeds into the insurer’s calculations and can result in a higher rate of income.
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