Over recent years, the financial planning world hasn’t had much reason to recommend annuities. But this has changed following a series of interest rate increases since the Budget last October. So, are annuities worth it? Previously, the rates were so low and due to the change in pension flexibilities, they lost their appeal. We look at the pros and cons, so you can see whether buying an annuity is the right choice for you.
How does an annuity work?
A pension annuity is a financial product that provides a guaranteed income for life in exchange for a lump sum payment. An annuity is purchased with pension savings, usually from a defined contribution pension scheme, and pays a regular income in retirement. The amount of income received depends on the size of the lump sum and the annuity rates at the time of purchase. Since the annuity rate increase, there has been a steady rise in sales.
Due to the impact of low interest rates and increasing life expectancy, annuity rates became less popular in the 90s and were in decline until 2020. One of the reasons is the increasing options available to retirees. But despite various retirement income products, such as drawdown and flexible access pensions, annuities still have a place in retirement planning.
There are different types of annuities – we have listed the main ones below:
- Lifetime annuity – this pays you a guaranteed income for the rest of your life.
- Fixed-term annuity – this pays you a guaranteed income for a set period of time.
- Investment-linked annuities – part of your income is guaranteed, the remaining part would be linked to investment performance.
- Enhanced annuities – this pays you an income that relates to specific health problems.
- Purchased life annuity – you can buy this in relation to money outside your pension pot.
Pros and cons for buying an annuity
The benefit of annuities is the fact they are simple and offer security. Unlike drawdown, which relies on investment returns and your ability to manage your money, annuities provide you with a guaranteed income for life. If you’re worried about running out of money in your retirement, this can provide you with peace of mind.
Annuities, however, do have some disadvantages. One of the biggest drawbacks is the lack of flexibility. Once an annuity is purchased, it cannot be changed or cashed in. This means you will have limited options if your situation changes or if you need to access a lump sum.
Annuity rates have been low in recent years due to low interest rates. They are linked with the yields on gilt and corporate bonds. As markets move up and down, so will annuity rates. Political factors, such as the Ukraine conflict, could also affect the financial markets.
So, up until recently, many retirees will have received a lower income than in the past for the same lump sum payment. However, you can build inflation protection at a cost to capital. So, while a standard annuity wouldn’t provide inflation protection, some annuity providers allow you to bolt on extras, such as inflation protection, to help personalise an annuity for an individual’s needs.
Despite these disadvantages, annuities might offer some people a suitable retirement income. Higher annuity rates are currently equating to investment returns on a drawdown arrangement, which means buying an annuity is worth considering.
An annuity could be worth it
To conclude, while low interest rates have made annuities less attractive in recent years, they still have a place in retirement planning. Annuities can provide retirees with a guaranteed income for life, and financial security in your retirement. However, you should also consider the lack of flexibility and the impact of inflation on your income.
In some cases, combining annuities with drawdown could create a retirement income plan that provides you with security and flexibility. Before you consider buying an annuity, please speak to our financial planners.
We’ll carry out a review and explain how much you’re likely to receive from your pension. Together, we’ll look at your options, so you can decide whether buying an annuity will be the right decision for you and your retirement.