- Annuities rates are rising
- They can be a good option if you are older or want security and peace of mind
- Shop around to get the best rate
Geopolitical uncertainty and an upward trajectory for interest rates mean that a guaranteed income in retirement is becoming more attractive than it has been in recent years. Since dropping the bank rate to 0.1 per cent at the start of the pandemic, the Bank of England (BoE) has initiated two rate rises over the past three months taking it up to 0.5 per cent. The BoE Monetary Policy Committee’s February report highlighted a market implied path for the bank rate to rise to around 1.5 per cent by the middle of 2023 as a rise in wholesale energy prices has fuelled inflation.
Russia’s invasion of Ukraine has placed further pressure on energy prices as Russia supplies around a third of Europe’s gas. The BoE is walking a tightrope – the economic implications of sanctions are not clear and further rate rises risk damaging the economic recovery.
This matters for annuities because the guaranteed income that they provide is calculated according to gilt (UK government bond) yield rates. “The 15-year gilt yield increased by 32 basis points to 1.46 per cent during January 2022 with providers of standard annuities increasing rates by an average 1.07 per cent,” says Divya Avda, financial planner at Tilney Smith & Williamson.
Since our report on annuities in September 2020 (IC, 25.09.20), the annual income from a £100,000 pension for a single life level annuity, with a five-year guarantee, for a person aged 65 has increased by 8.2 per cent, according to Hargreaves Lansdown. For an equivalent annuity linked to Retail Price Index (RPI) inflation, the rate is 4 per cent higher.
For someone taking out an annuity at age 75, the annual income received from a £100,000 single life RPI inflation-linked annuity is 4.7 percent higher than it was 18 months ago.
| Annual annuity income from a £100,000 pension |
| Type of annuity | Annual income at age purchased | |||||
| Age 55 | Age 60 | Age 65 | Age 65 (smoker*) | Age 70 | Age 75 | |
| Single life, level, no guarantee | £4,073 | £4,506 | £5,196 | £5,925 | £5,981 | £7,445 |
| Single life, level, 5 year guarantee | £4,069 | £4,498 | £5,165 | £5,879 | £5,919 | £7,289 |
| Single life, RPI, 5 year guarantee | £1,749 | £2,152 | £2,838 | £3,373 | £3,648 | £5,023 |
| Single life, 3% escalation, 5 year guarantee | £2,414 | £2,843 | £3,463 | £4,155 | £4,336 | £5,683 |
| Joint life 50%, level, no guarantee | £3,779 | £4,173 | £4,622 | £5,180 | £5,433 | £6,406 |
| Joint life 50%, 3% escalation, no guarantee | £2,151 | £2,545 | £3,005 | £3,503 | £3,721 | £4,824 |
Source: Hargreaves Lansdown 10.02.22
*Smoker annuity based on a 65 year old who has smoked 10 cigarettes a day for the past 20 years and drinks 15 units of alcohol a week.
“Annuity rates have been on the rise in recent months which is good news but they are rising from historic lows,” says Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown. “The potential for further interest rate increases means that they could rise further throughout the year so many people may choose to wait to see if they can get more for their money.”
Nick Flynn, director of retirement income at Canada Life, says that the insurer’s annuities case rates have increased four times this year. “This has in turn led to an increase in quotations and acceptances,” he adds.
When should I consider an annuity?
The annuities market has shrunk massively because the introduction of pensions freedoms in 2015 has meant that they are no longer the main option for retirees. People have been increasingly going into drawdown when they retire, allowing pension savings to benefit from extra investment growth. However, annuitising your pension pot in slices later on in retirement can be an attractive option if you want to remove some market risk.
Annuities often make sense for older people because the shorter the time you’re expected to live, the higher the rate you get. Annuities can also be a good option for surviving partners whose late spouse used to manage their pensions in drawdown, but now prefer the security and peace of mind of an annuity can provide.
The latest retirement income market data published by the Financial Conduct Authority shows that enhanced annuities make up more than a third of annuities purchases. You can purchase enhanced annuities if you have long-term health conditions or make certain lifestyle choices which your annuities provider considers will result in your life expectancy being shorter than average. Conditions which qualify for an enhanced annuity include:
- diabetes
- asthma
- heart disease
- high blood pressure
- cancer
- kidney failure
- smoking
- excessive drinking
Even where you live can be a factor, as some postcodes have lower life expectancies than the national average for reasons such as crime, pollution and poverty. One or more of these reasons could help you to qualify for an enhanced annuity and more money in retirement.
What type of annuity should I pick?
The level of annual income you receive from an annuity depends on a number of factors. First, you need to decide if you want a protection option. This guarantees the minimum number of years the annuity will pay out, for example five years. So if you die within that period, the income will be paid to a person you nominated for the duration of it. While this protection option slightly reduces your rate, Gary Smith, financial planner at Tilney, says that it is very unusual to take out an annuity without a guaranteed payment period.
You then decide if you want a joint life pension, whereby on your death the annuity is paid in full or in part to your spouse for the rest of their life. This decreases the rate further as it increases the amount of time the insurer is likely to have to pay out, but the rate is also influenced by the age and health of your spouse.
Morrissey points out that the latest retirement income market data show that almost three-quarters of annuities recently purchased were single life. “This is fine if you are single, but if you are married it means your spouse won’t get an income when you are gone,” she says.
Flynn adds that: “The majority of retirees should consider protection options with guarantees available of up to 30 years or 100 per cent value protection. These are available at minimal cost, for example, someone can have a 10-year guarantee for around £1 a month”.
You could also add inflation protection or a fixed escalation rate to your annuity. The starting income of a flat rate annuity is much higher than that of an index-linked one. If you plan to purchase a flat rate annuity you need to think about how you will deal with price increases over time, for example, do you have other sources of income to draw on? But also think about how long it would take for the income of an index-linked annuity to catch up with that of a level one. With a persistent inflation rate of 5 per cent it could take more than 10 years for the income to catch up and if inflation is lower it would take considerably longer.
“There is a natural break-even point if you choose an inflation-linked annuity and conversations with an adviser will help you work out the best option,” Flynn says.
How to get the best deal
Research by the Pension Policy Institute has revealed that approximately only 50 per cent of customers shop around for annuities so could be missing out on a higher income. The study found that some people buy an annuity from their existing pension provider and could be losing an extra £7,000 income per £100,000 over the course of their retirement by not shopping around.
The Pension Policy Institute estimates that in 2019 around £130mn could have been missed out on in the first year by annuities holders because they were not selective. The difference between the best and the worst rates can be quite substantial and, if you are in poor health, providing your medical records could substantially increase the rate of income you get.
