Understanding Annuities

As interest rates remain high annuity providers are offering more attractive deals, so should annuities form part of your pension income planning?

3 mins

According to data issued by the Association of British Insurers (ABI), the sale of annuities soared to £5.2 billion in 2023, an increase of 46% on 2022 figures [1]. This was the highest annual sales value since 2014, when pension freedoms were announced.

As interest rates remain high (the Bank of England has held interest rates at 5.25% since August 2023 in an effort to combat inflation) annuity providers are now offering more attractive deals, and annuities may be worth considering as part of your pension income planning.

[1] 16/02/2024 | 2023 sets new post-pension freedoms record for annuity sales | www.abi.org.uk

What is an annuity?

An annuity is a product that pays a guaranteed income — usually monthly — for at least as long as you live. You can buy one with some or all of your pension pot, or with your savings.

The amount of income you get from an annuity depends on how much money you use to set it up, plus factors such as your age, health, and lifestyle when you take it out.

Annuity payments are taxed as income, and the tax is usually deducted before you receive it.

Potential benefits of an annuity:

  • Annuities provide a guaranteed income for life, which can provide financial security in retirement.

  • Annuities shield you from stock market fluctuations, ensuring a steady income regardless of economic conditions.

  • Some annuities offer inflation-linked increases, helping to maintain the purchasing power of your income over time.

  • Impaired or enhanced annuities may pay a higher income if your health or lifestyle may shorten your lifespan – for example, if you have an existing health condition or you smoke or are overweight.

  • Annuities offer various options such as joint-life annuities, guaranteed periods, and different payment frequencies, allowing you to tailor the annuity to your specific needs.

  • You can use it to provide for loved ones by setting it up to continue paying an income after you die, although this will reduce the annual income you yourself receive.

Potential downsides of an annuity:

  • One of the main downsides of purchasing an annuity is its irreversibility. Once purchased, you typically cannot access the capital used to buy the annuity, meaning you lose control over your money.

  • Annuities may offer lower returns compared to other investment options, especially in times of low-interest rates.

  • Annuities are inflexible, and once the terms are set, they cannot be changed. This may not suit you if you prefer flexibility or anticipate that your financial needs may change.

  • While some annuities offer inflation protection, it usually comes at a cost or may not fully offset the effects of inflation, potentially reducing the purchasing power of your income over time.

  • If you die earlier than expected, you may not receive the full value of your investment, although some annuities offer options to address this through survivor benefits or return of capital features.

So should annuities form part of your pension income planning?

It's important to carefully consider your financial goals, risk tolerance, and individual circumstances before purchasing an annuity. It is also important to consider all of the options available to select the solution that best meets your needs, such as:

  • Flexi-Access Drawdown. This allows you to leave your pension savings invested while taking an income as and when needed. There are no limits on how much income can be taken each year, but withdrawals are subject to income tax. As your pension is invested its value can go down as well as up.

  • Uncrystallised Funds Pension Lump Sum (UFPLS). This allows you to take lump sums from your pension savings as and when needed, with 25% of each withdrawal tax-free and the remaining 75% subject to income tax.

  • Defined Benefit (DB) Transfers – you may have the option to transfer your DB pension scheme into a Defined Contribution (DC) pension scheme, which could provide greater flexibility and control over your pension savings. However, you may be giving up some very attractive benefits and this option should only be considered after taking advice. You must seek financial advice if the transfer value is £30,000 or more.

  • Leaving the Pension Invested – you may choose to leave your pension savings invested and draw an income from the investment returns. This option carries investment risk and requires ongoing monitoring of the pension investments.

  • It is also possible to combine different options to create a customized retirement income strategy that suits your individual needs and preferences, such as a combination of annuities, drawdown, and lump sum withdrawals.

Understanding your pension options is vital to planning for a comfortable retirement.
Always seek advice if you are uncertain about any aspect of your retirement planning and before making any decisions which cannot be reversed.

Please note: This content is for general information only and does not constitute advice. The information is aimed at retail clients only.

The content of this article was accurate at the time of writing. Whilst information is considered to be true and correct at the date of publication, changes in circumstances, regulation, and legislation after the time of publication may impact on the accuracy of the article.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by interest rates at the time you take your benefits.
Accessing pension benefits early may impact on levels of retirement income and your entitlement to certain means-tested benefits and is not suitable for everyone. You should seek advice to understand your options at retirement.