Sales of pension annuities have soared as rising interest rates mean much better returns for retirees – but many people remain sceptical about them.
Until recently, annuities, which typically pay out a set income for life to a pensioner, have been largely dismissed because of their poor value. But recent increases in interest rates, which have piled pressure on homeowners, have meant there are much better deals on the market.
It is now possible for a 65-year-old to get £7,100 a year if they invest £100,000 – compared with £5,500 just 12 months ago.
The Association of British Insurers (ABI) says sales were up 22% in the first three months of the year, to the highest level in almost five years. And Canada Life, a leading provider, says it is seeing the highest sales since before the announcement of so-called pensions freedoms in 2015.
But research shows scepticism remains. So are they a good option? And what should people consider before they spend their pension pot?
How they work
People can buy one by paying an insurer a lump sum. The insurer then guarantees an income. That could be for life, or for a set period; it could be the same every year, or be linked to inflation; and the payments could stop on death or be passed on to a spouse.
The major advantage is a guaranteed income, with the possibility that a family member could continue to receive it after death.
However, you will be locked in for either life, or a set period – such as 10 years – and they may not perform as well as other products, such as an income drawdown plan, which leaves your money invested and takes income direct from your fund.
For a number of years, the rates on annuities have been derisory, leading them to be dismissed as an option for many people approaching, or in, retirement. But with higher interest rates have come much better offers.
A typical annuity for a 65-year-old with no health concerns now pays just under 7%. Figures from Canada Life show that it takes 14 years to get your money back from a typical investment, compared with 19 in 2018.
Helen Morrissey, at investment platform Hargreaves Lansdown, says there is a “good chance” there will be further increases. “After years in the doldrums, these rising incomes have sparked a real interest in annuities again,” she says. “They should be a consideration for anyone who needs a level of guaranteed income in retirement.
“Incomes have increased markedly from even two years ago, and this is prompting more people to take a look and consider where they fit in their retirement plan.”
What can you get?
What type of plan a person is on, and what age they are, define how much income they get. According to figures from Hargreaves Lansdown, a 65-year-old who buys a plan with a guaranteed five-year income, where it pays out even if they die in that period, will receive £7,168 every year per £100,000 of pension cash.
The same plan bought by a 75-year-old would deliver £9,096. And if a 65-year-old opts for a 3% rise every year, they will get £5,194. Choose to pass half of the total to a spouse, or another beneficiary (a “joint-life” annuity), and they will get £4,715 per £100,000.
There is a huge difference between the best and worst value providers, according to Just Group, a financial company which specialises in retirement. It says there is an 18% difference between the two ends of the market – or about £1,000 a year for someone with a £100,000 pension. “Shopping around is particularly important because it’s the closest thing to ‘free money’ in the retirement world, and staying loyal to a provider can cost you dearly,” says Stephen Lowe of Just Group.
Should I buy one?
While annuities are currently offering good value, there is still confusion about them, according to research from Canada Life. A study shows one in five people think they are poor value.
Rebecca O’Connor of PensionBee, which specialises in combining old pensions, says that because annuities have been unpopular for so long, they now need to be explained to a new generation.
“At the moment, they are a bit like that thing on the menu in a restaurant: no one seems to know what it is, but once the waiter explains it, you’ll probably want it,” she says.
There are many options in terms of how to make annuities work, says O’Connor. “You could start with drawdown, then take an annuity; or you could start with an annuity, then go into drawdown; or have an annuity with some of your pot and drawdown with the rest, at the same time,” she says.
“The first option allows you to keep your pension invested for growth for longer, then take an annuity when rates are higher because you are older.
“The second option allows you to create a guaranteed income for a certain period with some of the pot – perhaps if you stop working before retirement age – then keep the rest invested for longer, so it can hopefully grow more in that time.
“The third option is a ‘best of both worlds’, perhaps, allowing some security from some guaranteed income, but allowing you to top up with any extra from the pension in drawdown.”
