Annuity incomes hit highest level in two decades - is now the time to buy one?

Annuity rates have improved by 20% over the past year. We look at whether now is a good time to buy an annuity.

Pensions signpost
(Image credit: © Getty Images)

Annuity incomes have continued to climb this year off the back of multiple base rate hikes by the Bank of England

The Bank of England raised interest rates for the 14th consecutive time in August, and the cost of borrowing is currently at 5.25%.

That compares with 0.25% in December 2021.

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The hikes mean a 65-year-old with a £100,000 pension could get an annuity income of £7,317 per year, according to the wealth manager Hargreaves Lansdown. This is up from £7,144 just a few months ago.

Two years ago, the same pension pot would have bought an annuity of just £4,946 a year. This means annuity rates have risen by almost 50% since 2021. 

According to Standard Life, annuity rates are now at their highest level in two decades. Back in August 2003, a 65-year-old man would have got a similar sized income from a £100,000 pension pot - £7,402 a year - as those on offer today. 

Pete Cowell, head of annuities -  individual retirement, at Standard Life, calls it a “new era for annuities”. He says: “Rising interest rates have renewed interest in annuities and the role they can play in people’s retirement income, particularly given the ongoing cost-of-living crisis, which has made the purchasing power of people’s income more uncertain.”

Data from the Association of British Insurers (ABI) shows sales of annuities have reached their highest level since 2014, surging 22% during the first three months of 2023. 

About 16,250 annuities were bought between January and March 2023, totalling £1.2 billion. This is the highest value since 2015 when pension freedoms were introduced giving people more flexibility over how to access their retirement savings.

Retirees have been taking advantage of these freedoms by shopping around for the best annuity deal. More than 10,000 people bought an annuity from a different provider to their pension savings provider, the ABI says, making up 64% of sales and totalling £847 million. In comparison, only 55% of sales were made with a different provider in the same period in 2022.

Stephen Lowe, group communications director of retirement specialist Just Group, says shopping around for a better rate is the “closest thing to ‘free money’ in the retirement world and staying loyal to a provider can cost you dearly”. 

It’s also important to note that once you have purchased an annuity, that decision is locked in, so it is essential you shop around.

The gap between the top and bottom providers has widened to the point that a healthy 65-year-old can secure 13% more annual income by securing the best instead of the worst rate, says Lowe. A healthy 75-year-old can get 16% more income from the best provider compared to the worst.

The income achieved could be even higher depending on lifestyle factors and medical history.

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. 

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 4.6%. 

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, comments: “Rising interest rates are one factor that feeds into annuity rates. It’s no certainty that we will see further increases, but it is a strong possibility, and we can expect retirees looking for a level of guaranteed income to keep a close eye on the market.”

Annuities have been out of favour among retirees for a long time, with just 10% of pension savings used to buy an annuity in the 2020-2021 tax year.

This is because pension drawdown is typically seen as more flexible, and better value for most retirees.

But experts say annuities are making 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. 

According to Hargreaves Lansdown, the number of annuity quotes run on its search engine has risen 120% when comparing August 2021 - July 2022 and August 2022 - July 2023.

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 it when you need – this is known as drawdown.

Is an annuity the right option for me? 

The main downside of taking an annuity is that the decision is irreversible.

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. One strategy is to use part of your pension to generate a regular and secure income and then access the rest via drawdown. This can give you more flexibility over how you take income from your pot and means you aren’t locked into one product or strategy.
  • You can only access your pension from age 55 but that doesn’t mean you have to buy an annuity straight away. You may prefer to use drawdown to begin with and buy an annuity as you get older. It’s worth noting that the older you are, the better the annuity rate so it may be worth waiting, although no-one can predict how long they will live.
  • 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 £60,000 each tax year (known as the annual allowance) and benefit from tax relief.
  • Be careful about how much annuity income you take. Annuity income is taxable, so it may affect any potential income-tax bill depending on money you are getting from other assets such as a buy-to-let.
  • 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.

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Marc Shoffman

Marc Shoffman is an award-winning freelance journalist specialising in business, personal finance and property. His work has appeared in print and online publications ranging from FT Business to The Times, Mail on Sunday and The i newspaper. He also co-presents the In For A Penny financial planning podcast.