Purchasing an ‘annuity’ simply means swapping your pension fund for a guaranteed income for life. However, annuities remain a topic of confusion for many people – and have sometimes been viewed as offering bad value. This perception may now be changing: ongoing raised interest rates have led to an increase in annuity rates, triggering a recent sharp rise in annuity sales.
Understanding types of annuities and annuity rates
There are many different types of annuities and options available in the marketplace, such as those that include inflation protection. An annuity ‘rate’ determines the level of income you will receive, and is based on different factors including your age and the value of your pension fund. Anything that might mean your life expectancy is reduced could mean you get a higher income. This is because annuity providers decide your income based on how long they think you will live. The longer they estimate you will live, the longer they will need to pay you.
Are annuities and interest rates linked?
Annuity rates are significantly influenced by interest rates and exhibit a direct positive correlation with them. Annuity providers tend to buy government bonds to create reliable returns for their customers. When interest rates go up, bond returns rise with them and this boosts annuity rates too. As an example, as of mid-September 2023, a 65 year old with a £100,000 pension fund would secure an annuity of £7,462 per annum¹, a sharp increase from an all-time low of £4,696 per year for equivalent circumstances in August 2016.
Annuity providers decide your income based on how long they think you will live.
The Bank of England plays a pivotal role in shaping the financial landscape, including annuity rates. When the Bank of England started raising interest rates in December 2021, annuity rates began to rise, triggering elevated sales of annuities. In 2023 interest rates increased even further, resulting in around 16,000 annuities being sold in the first three months of 2023, the highest figure since 2019².
Who might annuities be suitable for?
Those who are approaching retirement age and are seeking a reliable income stream for the rest of their lives may wish to consider an annuity. They could be attractive for individuals with a lower risk tolerance who prioritise financial stability and want to try to safeguard against outliving their savings.
Partial annuity purchases
In the realm of annuities, there exists a flexible option: partial annuity purchase. Instead of committing their entire savings to an annuity, clients can choose to invest a portion of their funds. This approach allows individuals to balance their need for a secure income with the desire to maintain liquidity and flexibility in managing the rest of their assets.
In summary
Understanding the correlation between annuities and interest rates is essential for making informed financial decisions: keeping an eye on the Bank of England's decisions and their impact on annuity rates can empower individuals to make prudent choices about their retirement. If you are considering an annuity, it is important to evaluate your options carefully and shop around. Quotes are only guaranteed for a limited time and annuity rates change frequently. Rates can also vary greatly between providers, and your current pension provider may not offer you the best deal.
If you would like further information on annuities, or to find out how our Wealth Planning team can help you with any aspect of your retirement, please speak to your Investment Manager.
The information provided in this article is of a general nature and is not a substitute for specific advice with regard to your own circumstances. You are recommended to obtain specific advice from a qualified professional before you take any action or refrain from action.
¹ Based on single life only with no spouses pension, level in payment with no indexation and no guarantee period in the event of early death.
² The Association of British Insurers.
