Annuities used to be an essential part of retirement planning, but they’ve fallen out of favour since the government introduced Pension Freedoms legislation in 2015. However, now that annuity rates are beginning to rise, they could provide financial security in retirement.

If you have a defined contribution (DC) pension, you’ll have a fund that you can use to create an income from when you reach retirement age. In this scenario, you are responsible for ensuring the income you take is sustainable.

One option that might better suit your needs is to purchase an annuity, which will provide a regular income for the rest of your life.

You can purchase a joint annuity if you’re planning retirement with a partner and can choose for the income to rise each year to preserve your spending power.

In the past, an annuity was a common way to create an income from a DC pension.

In 2015, Pension Freedoms gave retirees more options and flexibility, so the number of people purchasing annuities has fallen. However, rising annuity rates could make them more attractive once again.

The potential income an annuity delivers has increased by 28% in the first half of 2022

If you have £100,000 to purchase an annuity and are offered a rate of 4%, you’d receive an annual income of £4,000. So, the annuity rate directly affects your income throughout retirement.

According to a report in the Telegraph, the average annuity rate was 28% higher in June 2022 when compared to the start of the year. On average, a 65-year-old would receive an annuity rate of around 5.94% – the highest amount since August 2014.

Keep in mind that many factors will affect the annuity rate you’re offered, including your age, health, and lifestyle. A young, healthy person is likely to receive a lower annuity rate as the provider will expect to pay a regular income for longer.

If you want an annuity that will provide an income that rises with inflation or covers your partner, you should also expect the rate to be lower.

Rates can vary significantly between different providers. If you’re considering taking out an annuity, you should spend some time looking at your options, the different rates available, and weigh up the pros and cons.

4 benefits to choosing an annuity

1. An annuity will provide an income for the rest of your life

With the average retirement lasting several decades, you shouldn’t underestimate the value of having a reliable income for the rest of your life.

An annuity means you don’t need to worry about running out of money or whether withdrawals from your pension are sustainable.

2. Your income wouldn’t be exposed to market volatility

Some of the alternatives to annuities mean your pension remains invested. As a result, the value of the pension is affected by market volatility and could fall, which may affect your plans.

In contrast, the income you receive from an annuity is not exposed to this.

3. You can choose an annuity that is linked to inflation

Unsurprisingly, many retirees are thinking about how inflation could affect their income needs during retirement. The rising cost of living means that, to maintain your lifestyle, you will need a larger income in the future.

Not all annuities are linked to inflation, but it’s something you can choose. It’s an option that can preserve your spending power for the rest of your life and help you meet long-term retirement goals.

4. An annuity could provide an income for your partner

If you’re retirement planning with a partner, it’s important to consider how either of you would cope financially if the other passed away. While it can be difficult, it means you can take steps to ensure long-term financial security for the surviving partner.

A joint annuity will continue to pay an income, usually a proportion of the original income, to your partner if you pass away. This can provide peace of mind should something happen.

4 drawbacks to purchasing an annuity

1. An annuity isn’t flexible

During your retirement, there may be times you want to take a higher income or when your spending falls. Alternatives to an annuity mean you can adjust your income to suit your changing lifestyle needs.

However, you don’t have this flexibility with an annuity. You will receive the agreed income and can’t generally change it.

2. You could miss out on investment growth

A common alternative to purchasing an annuity is flexi-access drawdown. With this option, usually, your pension remains invested and could grow during retirement. As you’ll be removing your money from your pension to buy an annuity, you miss out on this potential growth.

However, while investing your retirement savings provides an opportunity for growth, this isn’t guaranteed.

3. Some annuities may have high management fees

Before you purchase an annuity, you should check what fees you will need to pay. Some providers may have high management fees, which can reduce your income. Fees may be a fixed rate or a percentage of your pension.

An offer that appears attractive initially may not be as good as it first seems once you consider the fees.

4. An annuity cannot be passed on

While you can choose a joint annuity to provide an income for your partner, you cannot pass on the benefits of an annuity to people that aren’t named on the policy if you pass away.

In some cases, you may receive less from an annuity than the amount you purchased it for.

Contact us to discuss annuities and your other options

If you have a DC pension and would like to review your options, please contact us.

We’ll help you understand if an annuity is right for your circumstances and goals, as well as explore the other options. Please contact us to arrange a meeting.

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 value of your investments (and any income from them) can go down as well as up, which would have an impact on the level of pension benefits available.

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of and reliefs from taxation may change in subsequent Finance Acts.