Annuity rates hold steady despite rate cut - is now a good time to buy an annuity?

Average annuity rates have risen 5% over the past year, despite two Bank of England interest rate cuts.

According to data from Hargreaves Lansdown, the average 65-year-old with a £100,000 pension pot can get up to £7,499 as annual income from a single-life level annuity with a five-year guarantee.

This compares to £7,104 three months ago, and £7,133 back in November 2023.

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Three years ago, the same pension saver would have received just £5,131.

Annuity rates have held up well in the face of two base rate reductions this year. The Bank voted to cut the base rate from 5.25% to 5% in August, its first cut in more than four years. Last week, rates were trimmed again to 4.75%.

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, tells MoneyWeek: "Annuity rates are riding high off the back of rising long-term gilt yields. The recent interest rate cut may bring some downward pressure in the coming weeks but the fact remains annuities are great value."

She adds: "The news that the Bank may take a more cautious approach to cutting rates over the coming months also spells good news for annuity incomes."

Annuities have soared in popularity over the past few years as retirees rushed to take advantage of a surge in annuity rates, meaning they got more money in exchange for their pension pots.

A total of 82,061 annuities were sold in 2023/24, up 39% compared to a year earlier, according to the Financial Conduct Authority (FCA).

Annuities could get a further boost due to the Budget announcement that pension pots will be liable for inheritance tax from April 2027.

"This will remove many people’s rationale for using income drawdown as they used it to pass the pension down generations tax-efficiently rather than draw an income from it. As they revisit their retirement income plans, many may opt to secure a guaranteed income through an annuity instead,” comments Morrissey.

If you're thinking of buying an annuity, we look at the outlook for annuity rates, and what you can do to ensure you get the best deal.

Will annuity rates fall?

While annuity rates are currently holding up well, gilt yields are likely to fall as a result of lower interest rates, which will negatively impact annuity rates.

Holly Tomlinson, financial planner at the wealth manager Quilter, comments: "Annuity rates are closely tied to government bond yields, which can be influenced by changes in interest rates. A reduction in the base rate may lead to lower bond yields, potentially resulting in less favourable annuity rates for retirees."

However, Morrissey points out that "we aren’t expecting the Bank of England to cut interest rates anywhere near as quickly as they raised them".

She adds: "Any falls in income should be much more gradual so you shouldn’t feel pressured into making a snap decision. Once bought, an annuity cannot be unwound so you need to make sure you are considering all relevant factors in your decision.”

Is an annuity right for me?

Just because rates are fairly 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.

The FCA data shows that pensions drawdown is the most popular option among retirees. Almost 280,000 people opted for drawdown in 2023/24, versus about 82,000 annuity purchases.

However, as previously mentioned, this could change as pension pots become liable for inheritance tax. Experts predict that savers may stop preserving their pensions to pass on to beneficiaries tax-free, and instead look at buying a guaranteed income with their pension. Swapping a pension for an annuity means you get rid of your pension, reducing the size of your estate and any potential inheritance tax bill.

One benefit of buying an annuity is the peace of mind it gives you. An annuity will pay out an income until you die, so there is no worry that you could run out of money during retirement.

A study from Legal & General and the Happiness Research Institute, an independent Danish think tank, reveals that annuity-holders are more likely to report lower levels of stress (51%) and the highest level of financial confidence (24% versus 21%) compared to those without one.

A potential downside with annuities is that, unless you choose a joint-life annuity, when you die, the income dies with you. So, if you only live a few years after you purchase the product, you won't have received much money from your pension.

Some people 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.

Joint-life annuities continue to pay an income to a beneficiary (such as a spouse or civil partner) after you die, while others do not.

You can buy an annuity at any time in retirement, so you could leave it until you are older – especially as the older you are, the higher the annual income.

For example, a 60-year-old buying an annuity could expect an annual income of about £6,270, according to research by Standard Life, whereas a 70-year-old could get an income of £7,810.

Pete Cowell, head of annuities at Standard Life, comments: "Rather than simply deciding whether to annuitise, people should consider how much of their retirement savings they could use to buy an annuity, as well as what age best suits them, and keep this under review if circumstances change, especially since annuity rates typically improve as you age."

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.

Retirees are potentially missing out on thousands of pounds worth of income by failing to shop around for the best annuity deal. About four in 10 annuities are still bought from the retiree’s own pension provider, according to the FCA.

Using a comparison site is a good starting point, Morrissey 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 this article: “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.