Is it a good time to buy an annuity as rates hit a 14-year high?

The average annual annuity income has risen by nearly £700 over the past 12 months, giving retirees who convert their pension pots into annuities a significant chunk of extra income.

Data supplied to MoneyWeek by Moneyfacts reveals that the average annual annuity income stands at £3,113 (February 2023), up £683 from £2,430 in March 2022. This is based on a single life level without guarantee annuity bought with a £50,000 pension pot. 

Annuity rates rose 44% last year to hit a 14-year high, thanks to soaring gilt yields, which have been turbo-charged by the Bank of England raising interest rates as it seeks to get inflation back under control.

The most notable hike in annuity rates was seen in October – just after the mini-Budget. 

Last time annuity rates were at this level was during the 2007-2008 banking crisis.

Currently, the Bank of England base rate is sitting at 4%; experts predict it could rise further, reaching around 4.5% this summer, which could lift annuity rates further.

With rates rising to the highest level seen in 14 years, could now be the time to buy an annuity?

We look at how annuities work, why rates have risen so much, and whether now is a good time to buy one.

Why are annuity rates rising?

Annuity rates are linked to government bond (gilt) yields, which soared last year, particularly following the mini-Budget in September. Bond yields have stabilised since Jeremy Hunt’s Autumn Budget.  

Back in January 2022, the 15-year gilt yield was around 1.15%. It reached 3.5% in mid-September, and following the mini-Budget shot up to nearly 5%, before the Bank’s emergency gilt purchases eased it back down. Currently, it’s around 3.6%. 

Helen Morrissey, senior pensions and retirement analyst at the wealth manager Hargreaves Lansdown, comments: “Annuity rates have fallen back since the dizzy heights reached in the aftermath of the mini-Budget but still remain almost 40% higher than the same point last year.” 

The sharp rise in annuity rates means a 65-year-old with a pension pot worth £100,000 who buys an annuity would now receive a guaranteed income of £6,340 a year, according to the pension provider Canada Life. This compares to someone who bought an annuity at the start of 2022, who would only receive an annual income of £4,521.

The break-even point – the point at which you would receive your original pension back through income – has also been reduced by six years, falling from 22 years to 16 years.

The increase in annuity rates is arguably one silver lining at a time when homeowners and first-time buyers are worried about mortgage rates, and households around the country are feeling the squeeze from the cost of living crisis.

Annuities have previously been out of favour among retirees, with just 10% of pension savings used to buy an annuity in the 2020-2021 tax year. Pension drawdown is typically seen as more flexible, and better value for most retirees.

But experts say annuities could be poised for a comeback following the rate rises, which will give retirees an income boost. Annuities are an attractive option for those who prefer the security of the guaranteed income they provide.

“Those looking to retire may be surprised to find annuity rates have improved, so those who decide to annuitise could be hundreds of pounds better off than if they retired at the start of 2022,” says Rachel Springall, finance expert at Moneyfacts. 

Is an annuity the right option for me?

If you decide to buy an annuity, it is worth noting that this decision is irreversible and therefore it is important to take the pros and cons of buying an annuity into careful consideration.

 Here are some things to consider:

• You don’t have to use all of your pension pot to buy an annuity. You could use part of your pension, and access the remainder of the cash via drawdown, which can give you more flexibility over how you take income from your pot.
• You can choose what age to buy one. You may prefer to use drawdown to begin with, and buy an annuity later. It’s worth noting that the older you are, the better the annuity rate.
• You can continue to pay into your pension pot after you’ve bought an annuity. But remember, the usual tax rules apply; most savers can contribute up to £40,000 each tax year (known as the annual allowance) and benefit from tax relief. 
• Annuity income is taxable, so it may affect any potential income-tax bill.
• Don’t just accept the annuity rate offered to you by your pension provider – always shop around for the best rate. Use the free annuity comparison tool from the government-backed MoneyHelper service to help find the best rate.
• If you’re unsure about your options, speak to a financial adviser or specialist annuity broker first. The wrong decision could end up being costly. 

“Despite an improvement to the average annual annuity income, retirees may well opt for drawdown due to the flexibility,” says Springall. But “should someone’s circumstances change, whether due to a deterioration in health or a change in attitude to risk, an annuity may be a suitable choice providing a guaranteed income during retirement, but this would depend on future annuity rate pricing. 

“Indeed, choosing part annuity and drawdown may suit those who desire a bit of flexibility but also a set income that a lifetime annuity can offer.”

It’s vital to shop around for the best annuity rate. According to retirement specialist Just Group, the gap between the best and worst paying annuities is around 14%. Choose a bad deal and you could lose out on thousands of pounds of cash over your retirement. 

“For many people buying retirement income could be one of the largest and most important purchases they ever make so they should not accept the first deal on offer from their own pension provider,” said Stephen Lowe, group communications director at Just Group.

What is an annuity?

An annuity is an insurance product that pays a guaranteed income for life in exchange for your pension pot. 

When you retire, you can choose to swap your nest egg for an annuity, or keep the pension as it is and take cash from when you need – this is known as drawdown.

There are different types of annuities:

• an enhanced annuity – this pays a higher amount if you are ill or a smoker, factors which the insurer believes will affect your life expectancy
• an index-linked annuity – this is linked to inflation
• A “joint life” annuity – this pays an income to a spouse when you die. 
• fixed-term annuities – pay an income for a fixed period, say ten years, rather than for your whole life.