Annuity rates rise 6.5% over past year - is now a good time to buy one?

Annuities are back in fashion, with sales leaping 46% last year, and annuity rates rising 6.5%. But with interest rates forecast to fall, what sort of value can you get from an annuity, and should pension savers buy one?

Pensions signpost showing different options, including annuity, do nothing and take cash
Should you buy an annuity with your life savings?
(Image credit: © Getty Images)

Annuities had a bumper year in 2023, hitting £5.2 billion in sales, according to the Association of British Insurers (ABI).

It marks a 46% increase on 2022 and the highest annual value in annuity sales since 2014 when pension freedoms were announced, giving people more flexibility over how to access their retirement savings.

Meanwhile, annuity rates have risen 6.5% over the past 12 months. Data from Standard Life shows that a 65-year-old looking to buy an annuity with a £100,000 pension pot would have received an average annual income of £6,890 in February - an increase of £440 compared to February 2023.

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The insurance product has made a comeback thanks to rising interest rates, which have boosted the income that pension savers earn from them.

The Bank of England has hiked interest rates from 0.1% to 5.25% over the past two years. Annuity rates are priced based on returns on long-dated bonds, or gilts, which have surged due to high inflation and rising interest rates.

The number of annuity contracts sold also increased in 2023, to 72,200. This is 34% higher than in 2022.

Annuity rates rocketed skywards during 2022, and surged in the aftermath of the mini-Budget, with average annuity rates for a 65-year-old pushing 7.5%.

They have since fallen back a bit - to 6.89% - but are still higher than a year ago. The Standard Life data shows that annuity rates dropped slightly towards the end of 2023, following a decrease in yields. But rates are again trending upwards, with an increase of about 3% between December 2023 and February 2024.

Pete Cowell, head of annuities at Standard Life, comments: "Rates continued to improve throughout 2023, giving people more for their money than before. While movement in rates can be expected, with fluctuations observed during the fourth quarter of 2023, what’s important to note is that we are unlikely to see rates fall to the historic lows seen previously."

An interest rate cut - or signs that a rate cut is about to happen - will likely reduce annuity rates, so the value that annuity customers get could tumble in future. Note that if you have already bought an annuity, any change in annuity rates will not affect you as your income has already been guaranteed.

Helen Morrissey, head of retirement analysis at the wealth manager Hargreaves Lansdown, says an interest rate cut is not expected for another few months. "The Bank of England's pause on interest rates last month was widely expected and will add to the settled nature of the annuity market.

"With an interest rate cut not due on the horizon for another few months, annuities continue to offer really good value and interest in them will continue to grow.”

Why are annuity rates rising?

Annuity rates are linked to government bond (gilt) yields, which have soared in recent years, particularly following the mini-Budget in September 2022. 

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%. 

Annuities had 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 annuities are now much more attractive given the higher annuity rates - and therefore annual incomes that pension customers receive.

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.

Annuities are an attractive option for those who prefer the security of the guaranteed income they provide. 

There are different types of annuity. For example, a joint annuity pays an income to a spouse or civil partner when you die. An escalating annuity - also known as index-linked or inflation-linked - pays a lower starting income but then increases each year.

Meanwhile, an enhanced - or impaired - annuity pays a higher income due to the customer having an illness or health condition. For example, if you're a smoker, have diabetes, or have cancer. 

Annuities will also pay a higher income the older you are. For example, from the same £100,000 pension pot, a 60-year-old could secure an average annual income of £6,260, according to Standard Life. A 65-year-old would receive £6,890 while a 70-year-old would get £7,710.

Separate data from the Financial Conduct Authority shows that escalating and enhanced annuities are now accounting for a higher proportion of sales. Escalating annuities make up almost a fifth (19%) of annuity sales, up from 13% four years ago.

Enhanced annuity sales have also risen markedly over the past four years, from 35% of all sales, to 44%.

Stephen Lowe, group communications director at retirement specialist Just Group, says it is "positive" that more customers are opting for more complex products that may be "more appropriate for their circumstances or offer a higher level of income".

He adds: “Our own analysis suggests around two-thirds of pension savers could be eligible for enhanced rates so we are creeping towards a more positive level of take-up."

Is an annuity the right option for me? 

The main downside of taking an annuity is that the decision is irreversible. So, it's important you think carefully before buying one - and it's also essential to shop around and not just accept the quote your pension provider gives you. 

The gap between the top and bottom providers has widened to the point that a healthy 65-year-old can secure 11% more annual income by securing the best rate instead of the worst one, according to retirement specialist Just Group. A healthy 75-year-old can get 17% more income from the best provider compared to the worst.

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

Here are some other 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.
  • 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.
Ruth Emery
Contributing editor

Ruth is passionate about helping people feel more confident about their finances. She was previously editor of Times Money Mentor, and prior to that was deputy Money editor at The Sunday Times. 

A multi-award winning journalist, Ruth started her career on a pensions magazine at the FT Group, and has also worked at Money Observer and Money Advice Service. 

Outside of work, she is a mum to two young children, a magistrate and an NHS volunteer.