That could be over £20,000 over the course of a 20-year retirement and that’s rare good news as the cost of living soars. Annuity rates are expected to rebound sharply as they are partly deducted from interest rates, which rebound as the Bank of England raises base rates to curb runaway inflation.
An annuity is the income you buy with your retirement pension. It’s guaranteed to continue for the rest of your life no matter how long you live, providing enormous financial security.
Annuities fell out of favor after the financial crisis, when yields fell to historic lows after the Bank of England cut interest rates to almost zero.
In 2016, a healthy 65-year-old man with a £100,000 pension had the lowest pension income of just £4,696 a year, according to the Sharing Pensions website.
Few retirees were willing to lock themselves into such low yields, but demand is picking up as interest rates rebound and annuity rates follow.
Today, annuity provider Just Group pays a 65-year-old man a £100,000 pension income of £5,082 a year, according to Hargreaves Lansdown. That’s an 8% pay rise from previous lows – worth an extra £386 a year.
Over a 20-year retirement, the additional income would total £7,720.
This is just the beginning, as annuity rates still have a lot to go up.
In December, the Bank of England raised its key rates from 0.1% to 0.25%. Annuity rates responded by jumping 5.4% in January, according to provider Canada Life.
The BoE rose again on February 3 to 0.5%. That has yet to affect rates, but it will soon, said Becky O’Connor, head of pensions and savings at Interactive Investor.
She said: “The higher interest rates climb over the next year, the more annuities are likely to pay.”
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Markets expect the Bank of England to raise interest rates another four times by the start of 2023, which would take base rates to 1.5%.
Canada Life calculates this would add another 14% to annuity rates, on top of the January jump.
This makes a total retiree wage increase of more than 20 percent. This would raise the income of someone aged 65 with a £100,000 pension to £5,793 a year.
That’s £1,097 a year more than the 2016 low of just £4,696. Over 20 years this would generate a total additional income of £21,940.
An annuity isn’t right for everyone, but the case for buying an annuity is getting stronger as rates recover, said Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown.
“The importance of a guaranteed regular income in retirement cannot be underestimated and annuities can therefore play an important role in retirement planning.”
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Withdrawal offers greater flexibility, but it also carries a higher risk, as your pension could be depleted in the event of a stock market crash.
Morrissey said there was another downside. “While some retirees are keen to manage their investments through deductions when they retire, they find it more difficult as they get older.”
Many prefer the security of an annuity later in life. This means that their income will continue even if stock markets crash, while pension funds held on the decline could plunge in value.
Rather than buying an annuity now, it may be worth waiting for rates to rise further, Morrissey said. “You don’t have to pay off your entire pension in one day, you can do it in installments over several years.”
A major disadvantage of annuities is that you cannot inherit them. “If you buy an annuity and then die a year later, you won’t get much value out of it,” Morrissey said.
You must also choose between a level annuity, which plays a fixed income, or an inflation-linked policy. Couples must then decide whether to purchase single or joint life annuities.
Once purchased, an annuity cannot be canceled, so understand what you are doing to minimize errors, Morrissey added. “Think carefully and consider taking advice.
