When interest rates started going up in early 2022, commentators discussed the possibility of annuities as a retirement strategy making a comeback. Once the standard option for retirees, low interest rates made annuities very unpopular and poor value for money, even before pension freedoms made them redundant. But higher interest rates meant they looked attractive for the first time in years.
Data from the Financial Conduct Authority (FCA) suggests that the comeback did not quite materialise, or not as quickly as some might have thought. In the 2022-23 financial year, annuity sales dropped by almost 14 per cent year on year, while new drawdown policies were up by 6 per cent.
This came as a bit of a surprise. “One would have expected as interest rates started to rise, particularly in the wake of the mini-Budget, that we would see annuity sales go up,” says Tom Selby, director of public policy at AJ Bell. Interest rates in the UK did not peak until August 2023, so data for 2023-24 might well tell a different story when these figures are published. But still, it is not entirely surprising that drawdown remained the preferred strategy for many people who retire, and the drawbacks of annuities should not be underestimated, even now that rates look much more palatable.
A guaranteed income for life is very valuable, but if it does not increase over time, its real value will be depleted over retirement. Escalating annuities remain comparatively unpopular because they tend to be expensive. Normally with a standard annuity, the income stops once you pass away, so how much you get out of it depends on your life expectancy. You have a few options to mitigate this, such as setting up an annuity guarantee period or purchasing value protection, which protects part of the value of your pot so it can go to your beneficiaries if it has not been paid out yet. But once again these come for a price.
Meanwhile, the key advantage offered by drawdown in retirement is flexibility – you take how much you need, whenever you need it, and let the rest grow, potentially achieving higher long-term returns if you invest in equities for a number of years. Selby says: “It may be that some people feel that locking in an annuity is a risk. If you lock in an annuity and you're healthy, say at the age of 65 or 70, and then you fall into ill health or you need care, then you're locked into that retirement income for life.” Unlike annuities, pension pots in drawdown are also a tax-efficient way to pass on wealth to your beneficiaries, because they escape inheritance tax and can also be free of income tax if you die before the age of 75.
But it is true that annuity rates have increased a lot. You can try to combine the best of both worlds by using a portion of your pot to purchase an annuity and secure a basic guaranteed income, especially if for some reason you do not qualify for the full state pension. You can then keep investing the rest and use drawdown to top up your income. With annuity rates unlikely to get much higher than they are, this could be a good time to lock in this strategy if it appeals to you.
