Should you buy an annuity as rates start to rise?

Pensioners who want to use their retirement savings to buy an annuity for a guaranteed yearly income can now earn more as interest rates rise.

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.

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.

Recommended

The best one-year fixed savings accounts - February 2023
Savings

The best one-year fixed savings accounts - February 2023

Earn almost 5% on one-year fixed savings accounts.
3 Feb 2023
Best regular savings accounts – February 2023
Savings

Best regular savings accounts – February 2023

Looking to stash small amounts away each month? You can now earn as much as 7% on regular saving accounts. We list the ones worth looking at.
3 Feb 2023
Which supermarket is the cheapest?
Personal finance

Which supermarket is the cheapest?

With food inflation hitting almost 17%, we look at which is the cheapest supermarket, plus the Competitions and Market Authority’s plan to introduce u…
3 Feb 2023
After slumping 42% last year, what's next for Scottish Mortgage?
Investment trusts

After slumping 42% last year, what's next for Scottish Mortgage?

After a spectacular couple of decades, the Scottish Mortgage Investment Trust fell by 42% last year. We take a look at the trust's performance and dis…
3 Feb 2023

Most Popular

NS&I brings back one-year fixed bonds with highest rates since 2010
Personal finance

NS&I brings back one-year fixed bonds with highest rates since 2010

NS&I’s one-year fixed bonds are back on sale after being pulled off the market in 2019 - but is the rate any good?
1 Feb 2023
Bank of England raises interest rate to 4%
Economy

Bank of England raises interest rate to 4%

The Bank of England raised rates by 0.5%, marking the base rate’s 10th consecutive increase.
2 Feb 2023
When will interest rates go up?
UK Economy

When will interest rates go up?

Interest rates are now at 4%, and they could rise further in the months ahead.
3 Feb 2023