Good news for those thinking of using their pension savings to buy an annuity in retirement: the rates available on annuities, which pay a guaranteed income for life, have kept climbing in line with rising interest rates and gilt yields. They are now at their most generous level in almost a decade.
Last month, a £100,000 pension fund would have bought a typical 65-year-old man an annual income of £6,168 for life, according to financial-planning website SharingPensions. This level of income is around 20% higher than what was available at the beginning of the year – and compares with an all-time low of £4,696 in August 2016.
The income you can actually secure for a given amount of pension savings will vary enormously, depending on what you want from your annuity. The most expensive annuity features could reduce your income – at least initially – by close to half.
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Three key factors
Three things make a difference above all. First, do you want a guarantee that your annuity will pay out for a minimum period, even if you die in the meantime? Many savers value such guarantees because annuities have always been regarded as a gamble. Once you die, your annuity income normally stops, no matter how much pension money you handed over at the beginning of the deal. Guarantees provide some insurance in this regard.
Issue two is inflation protection. One option is to buy a level annuity – this pays out the same annual income year after year, with inflation steadily eroding the value of this cash. Some savers therefore want an annuity that automatically rises in line with inflation each year, or guarantees a rise matching at least some of the prevailing inflation rate.
Finally, what about dependants? If you buy a single-life annuity, it pays out until the end of your life only (or to the end of the guaranteed period, if you’ve selected that option). Joint-life annuities, by contrast, continue to pay out an income to a dependant – typically your spouse – even after your death.
All three of these features have value, but they come at a cost. Data published by Hargreaves Lansdown earlier this year featured a 65-year-old man offered a single-life, level annuity, with no guarantee period, of £5,196 a year. Adding a five-year guarantee brought that rate down only marginally, to £5,165 a year, but inflation protection in the form of a 3% annual increase would have seen it fall to £3,463 – and full inflation-proofing with a link to the retail price index (RPI) would have brought it down to only £2,838. Joint-life options also greatly reduce the income available.
Getting the best deal on annuities therefore requires some decision-making, as well as an element of forecasting. If you think inflation is going to remain very high for the foreseeable future, you may be prepared to accept a lower annuity rate today in order to secure long-term protection from value erosion. If you think inflation will drop back below 3% and stay there, why would you accept less annuity income by opting for a full link to the RPI rather than 3% increases?
Get expert advice
Given these nuances, taking independent financial advice on your annuity purchase makes sense. Online quotes are good starting points, but expert advice can help you get the best value. This is important, as once you’ve bought the annuity, you’re stuck with it for good.
Even if you decide to go it alone, don’t break the golden rule of annuity purchases: never accept an annuity offer from the pension company with which you are saving before seeing what else is available. It may be the best deal in town, but if you shop around there is a good chance that better rates are available elsewhere.
Finally, don’t overlook the potential of an impaired-life annuity. These are aimed at pension savers with limited life expectancies. Since the insurer does not expect to have to pay out for as long as with a typical annuity, it can offer a much higher income from the outset.
Impaired-life annuity contracts are far more widely available than in the past. You may be eligible for a higher rate simply because you smoke (or used to), or are heavier than average. People who have spent their career in certain professions may also be able to get better rates. Here, working with an independent financial adviser who understands which annuity companies offer the best rates for someone with your circumstances can really pay off.
David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.
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