Could an annuity provide the retirement security you need?

Since the introduction of Pension Freedoms in 2015, pension drawdown – flexibly drawing an income from your pension fund while the rest of it remains invested – has become the favoured option for many retirees.

However, this trend may change in the near future because annuity rates are rising, and during a period of uncertainty, financial stability is a priority for many retirees.

As inflation remains high and investments are potentially vulnerable to market volatility, you may be wondering whether an annuity can offer that security.

Read on to learn more about how annuities work and some of the pros and cons.

Annuity rates increased by 20% in the 12 months to July 2023

When you purchase an annuity, you are essentially buying an insurance product that pays a regular income.

Many annuities pay a set amount over the course of your life – sometimes rising annually in line with the cost of living. Alternatively, you can purchase a fixed-term annuity that pays a guaranteed income for a set amount of time – usually 10, 15, or 20 years.

The income that you receive, often referred to as the “annuity rate”, varies depending on several factors including the value of your pension pot, your age and health, and how long the annuity lasts.

According to Standard Life, the average annuity rate increased by 20% in the 12 months to July 2023 and they are now at their highest level since the 2008 financial crisis. This could amount to an extra £25,000 in income in retirement for the average 65-year-old man.

Consequently, you may be considering using a portion of your pension, or the entire fund, to purchase one.

However, there are some potential downsides to consider and, in some cases, pension drawdown may be a more suitable option.

It is also important to note that you could choose a combination of annuities and pension drawdown.

The pros and cons of annuities


There are many options to suit your circumstances

Annuities offer a certain level of flexibility because there are many different types to choose from including:

  • Fixed-amount annuities – This type of annuity provides a guaranteed income for the rest of your life.
  • Fixed-term annuities – This type of annuity provides a guaranteed income for a certain period. The period varies but is normally 10, 15, or 20 years.
  • Joint-life annuities – Joint-life annuities pay an income to the annuitant – the person who purchases the annuity – and their chosen beneficiary. One of the major benefits of joint-life annuities is that the surviving partner will continue receiving an income if one of you passes away. You can decide how much your beneficiary receives and the income you receive while alive depends on this. For example, if you want your beneficiary to receive 100% of the income that you receive, your payment will be lower than it would if they only received 50%.
  • Enhanced annuities – These annuities pay out at a higher rate if you have a health issue, or if other lifestyle factors mean you’re likely to draw income for a shorter period.
  • Immediate needs annuity – An immediate needs annuity can be used to cover care costs. The income can be paid directly to the care provider, and if you choose this option, it is tax-free.

Some annuity providers may also offer other options. As such, you should be able to find an annuity that suits your life circumstances and your goals in retirement.

You receive a guaranteed income

You may be concerned about how far your pension savings will go while the cost of living is rising. As a result, the guaranteed income from an annuity may be very attractive right now.

If you put your pension into drawdown, you will likely need to take a higher income to fund your lifestyle when inflation is high. Additionally, during a period of market volatility, you may have to sell more units to generate your desired level of income.

This means that you could spend your pension much faster and you risk running out of savings.

A fixed-amount annuity, on the other hand, guarantees your income for life so you do not need to worry about this.

You can buy an inflation-linked annuity

Many people consider inflation to be an important part of a well-functioning economy. So, while inflation may slow down in the future, the cost of living will likely continue rising over time.

Fortunately, there are options for “inflation-linked” annuities so you can account for this. When you purchase one of these annuities, the income you receive from it rises with inflation, meaning you can maintain your lifestyle.

Note that you will typically receive a lower income to begin with, and a higher income later as and when your income rises in line with inflation. This could mean making some short-term sacrifices to your lifestyle so you can protect yourself against inflation in the future.


You may have less flexibility

The lack of flexibility is one of the main reasons that you may opt for pension drawdown instead of an annuity, especially during a period of uncertainty.

When you buy an annuity, you cannot usually reverse the decision and your income is fixed, unless you buy an inflation-linked annuity. This means you typically cannot choose to increase or decrease the level of income you receive, even if your circumstances change.

If you do not have an inflation-linked annuity, this can be a problem if living costs rise. You may also face hurdles if you decide to make changes to your retirement lifestyle or pursue new goals, because you cannot adjust your income accordingly.

You do not benefit from market growth

If you transfer your pension into drawdown, any funds that you have not taken as income usually remain invested and you may benefit from market growth.

However, this is not the case with annuities, so your retirement income remains static. That said, you do not assume any risk either.

As such, you may need to consider which you value more – the potential for growth on your retirement savings or the security of knowing your income won’t fluctuate.

It may be harder to pass wealth to your loved ones

Passing wealth on to loved ones may be a priority for you when creating a financial plan and you may want to consider how purchasing an annuity could affect this.

You can generally pass your pension on to your beneficiaries when you die, and they typically don’t have to pay Inheritance Tax (IHT) on it.

Annuities, on the other hand, often stop paying out when you die and the remaining funds cannot be passed on.

There are exceptions to this including joint-life annuities, for example, but they typically pay a reduced amount to the surviving partner. As such, you may not be able to pass on all your remaining savings to your loved ones.

It is important that you consider this when buying an annuity to ensure you can create an estate plan that aligns with your wishes.

Get in touch

If you need some guidance about annuities and whether they are the right choice for you, please get in touch today.

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Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

Posted in Financial Planning, Financial Services, News, Newswire.