Jasmine Birtles
Your money-making expert. Financial journalist, TV and radio personality.
Annuity Rates Explained
Reading Time: 5 minutesAs you get close to retirement age, it’s likely that you’ll start thinking about the options you have for your pension pot. You might be asking whether you cash it in or keep it invested, or what products are best if you want it paid monthly to replace your working income. What about an annuity vs drawdown – which is the best option?
Until 2015, an annuity was the most common way for people to access their money after retirement. That year, though, pension rules changed to offer more freedom and choice within the sector. Now, there are many other options – buying an annuity is no longer a given.
Here, we’ll think about annuities – just one of the options that you might want to consider if you’re nearing the end of your working life.
- What is a Pension Annuity?
- Different Types of Annuity
- Pros and Cons of Annuity
- Do I Need An Annuity?
- How to Find a Deal
- Alternatives to Annuities
What is an annuity?
An annuity is a long-term investment, usually offered by banks or pension providers to those over the age of 55. An annuity can guarantee you an income for life, as it converts your savings into an annual pension. You receive this payment after retirement. When and how, and at what rate, depends on which type of annuity product you go for.
As a product, an annuity is likely to be offered to you as you reach retirement age. It is a plan for what to do with your pension, i.e. the money that you have already saved through your working life.
Different types of annuity
There are various different types of annuity, which Age UK explains in great detail. Here is a quick overview of what they are and how they work:
- Lifetime – as its name suggests, this type of annuity will pay you an income for the rest of your life
- Guaranteed – provides a guaranteed income for life, at a set rate
- Joint life – this type of annuity pays your spouse an income in the case of your death
- Fixed/short-term – this type of annuity uses only part of your pension pot, thus providing a short-term income and leaving the rest of your pension invested
- Level – offering the same income each year, a level annuity is vulnerable to inflation in the same way that your pension pot is whilst you’re working
- Escalating – with an escalating annuity, the amount you receive each year will increase at a fixed rate
- Inflation linked – rising each year in line with the retail price index
- Enhanced/impaired – may pay out more in a shorter amount of time, for example if you have a life-limiting condition.
Different types of annuity will be right for different people, so you should consider various factors (including your lifestyle, and any other sources of income) before you commit to buying a specific product.
A lifetime annuity, for example, is a good choice if you’re in excellent health. If you outlive the annuity provider’s estimations, you’ll be receiving pure profit. However, if you’re not in great health, a fixed-term annuity with health premiums is one way to get paid more over a shorter period of time.
Pros and cons of annuity
As with any financial or investment products, there are both pros and cons related to annuities. Here are just a few of them…
Cons of annuities
- You can’t exit an annuity once you’ve taken one out – policies are irreversible
- Similarly, you can’t make changes to your annuity if your lifestyle or circumstances change
- Some products, as detailed above, are vulnerable to the rose and fall of interest rates
- There is little chance of growing the money you have invested
- Some policies will have a high fee
- If you don’t opt for a lifetime annuity, your remaining funds might not be enough to purchase another annuity or other investment option.
Pros of annuities
- If you take out a policy that guarantees you an income for life, your initial investment could be repaid many times over
- The right annuity product can guarantee you security for life
- Rates have risen since annuities became optional in 2015, with guaranteed income rising sharply and are expected to continue improving
- You can guarantee income for your spouse in the case of your death
- Annuities can protect you against inflation (depending on the policy you take out)
- They can also provide a higher income for those with illnesses or health problems.
It’s important to note that you might read about annuities being a bad deal due to rising life expectancy – i.e., that the income they provide is lower as the policy has to pay out for longer. This is no longer the case, however, as in recent years life expectancy has actually been falling. This means that annuity rates are improving. So, whilst this might not be great news overall, it does make annuity a better option than it might have been just a few years ago.
Do I need annuity?
No, you don’t need to get annuity. There are various options for what you can do with your pension pot or your other savings. These are outlined in more detail below.
You also don’t need to buy one from your pension provider. Many people still aren’t aware that they can shop around for the best deal – and it’s really important to do so, otherwise you could lose out on thousands of pounds income over your lifetime.
If you’re not sure about your pension options, remember you can always speak to the Pension Wise service for free.
How to find a deal
As with anything, it’s a good idea to shop around providers before you settle on a product. Start with your pension provider to get a ballpark figure for loyal customers. Use this figure to shop around with. Look at lots of different providers and check what they offer so that you can find the best deal for you. It may benefit you to seek independent pensions advice from an advisor or pension broker, as they’ll have access to deals not available to customers who go direct.
Consider the rates and other fees (which can sometimes be high). You need to be clear about your own circumstances, too. For example, if you have health conditions and take out a lifetime policy, you could end up getting more money back than your pension pot if you outlive their estimations. Obviously, you can’t know if this is going to be the case. But it is something to consider if you have specific circumstances.
Alternatives to annuities
There are alternatives to buying an annuity. Here are just a few of them…
- Drawdown – similar to an annuity in that it provides you with an income. The significant difference is that your pot will still be invested, meaning it can grow (or, of course, fall). This might appeal to those who still want to actively manage their pension investment after retirement.
- Lump sum – you can choose to take lump sums from your pension pot. The first 25% of your pot (or 25% of each sum) is tax-free, and the rest is taxed at basic income level. This might work for you if you want to travel, invest in something separately after retirement, or invest in another property (and have enough saved in your pot to do so).
- Lump sum plus drawdown – you can, of course, combine a lump sum with a drawdown.
Have you decided to take out annuities as you reach retirement age? We’d love to hear about it – let us know over on the forums.
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Need more advice about your future pension plans? Try these articles next!
- Are You Missing Money? How to Track a Lost Pension
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- Pension Pot of £100,000: What Are Your Options?
- How to Decide What to Do With Your Pension Pot
- Retiring Abroad – Your State Pension
All advice on pensions is gratefully received as it can be a confusing subject.