Annuities are the comeback kids of retirement planning

Rising interest rates have seen annuities, once reviled by nearly everyone, make the biggest comeback since Lazarus. The attractive income they now offer to people who want to use their pension pot to fund their retirement means they are back on the shopping list of many retirees.

The math is convincing. Ten years ago, you could buy a retirement annuity that would pay a guaranteed annual lifetime income of 4 percent. In other words, for every £100,000 of pension fund converted into an annuity, a pensioner would secure an annual income (paid monthly) of £4,000.

Today, mainly due to rising interest rates and higher bond yields, annuity buyers can get a lifetime income of 7 percent.

According to asset manager Evelyn Partners, a 65-year-old with a £100,000 pension pot can now buy an annuity that pays an annual income of £7,144. If this person were then to retire for 20 years, they would have paid £100,000 for a lifetime income of £142,880.

Experts say the income now being offered from new annuity purchases is comparable to what it was before the 2008 financial crisis — a catastrophe that ushered in an era of low interest rates and caused the death of the annuity market.

Henrietta Grimston is an associate director at Evelyn Partners. She says the coming months will be “an attractive buying opportunity for those seeking the security of guaranteed retirement income that annuities provide.”

Mark Ormston, director of annuity specialist Retirement Line, says it is not inconceivable that annuity rates could rise to 10% if, as widely predicted, the Bank of England’s base rate rises to 5.5% in the coming months.

Still, Billy Burrows, an annuity expert and founder of the Retirement Planning Project, is more cautious about the future direction of annuity rates.

He says, “Annuities are a great value right now. With signs of inflation being brought back under control, bond yields and annuity rates are unlikely to rise much further. So it could be a good time to purchase an annuity.”

Annuities can be purchased by people who have a pension fund set up on a defined contribution (or money purchase) basis. Such arrangements are now commonplace.

Sales figures show that annuities are now firmly back on the radar of many retirees. According to the Association of British Insurers, annuity sales rose 22 percent in the first three months of this year as savers looked for financial security in retirement.

The amount of money from the pension fund used to secure these annuities was £1.2 billion. This is the highest quarterly figure since 2015, when the coalition government introduced measures to give retirees more choice about how they use their pension pot to fund their future lifestyles.

These measures, referred to as ‘pension liberties’, were partly intended to provide retirees with options other than the straitjacket of an annuity.

Since the then Chancellor of the Exchequer, George Osborne, introduced these rules, pensioners with defined contribution pension pots have been able to access them at will – provided tax is paid on amounts above the tax-free money they are allowed to withdraw, which is usually 25 percent of the value of the pension pot.

Lorna Shah is a general manager at legal & general insurance company. She says, “Annuities give you guaranteed income for the rest of your life, regardless of what happens to the interest or what happens in the world. They are a good option for people who want peace of mind and the security of a guaranteed lifetime income.’ Still, there are drawbacks. While the previous examples show how well people could do if they bought an occasional annuity and then lived another 20 years, not everyone lives that long.

For these people, annuities offer little value for money – although policies can be taken out on a joint living basis, meaning they continue to pay an income (albeit deducted) to the surviving spouse.

When taking out an annuity, the buyer can choose a beneficiary to continue receiving their income, although this is more expensive.

Also, the examples mentioned are for ‘fixed’ annuity income. If you want a regularly rising income to combat inflation, it will cost much more. The same £100,000 would buy you just £5,086 in annual income, increasing at 3 per cent per annum.

Is pension accrual a better option?

While annuities are back in demand, they won’t be everyone’s cup of tea.

Drawdown is an alternative way of using a retirement fund to fund retirement. This is where the pension fund remains invested, with any withdrawals being financed by selling part of the assets of the pot.

With such a scheme you are in control of how and when you receive income from your pension. For example, it allows you to withdraw money to cover major card items, such as home improvements or the purchase of a new car. Drawdown also means that the value of your retirement pot has the potential to continue to grow, although it could also decline if stock markets deteriorate. You can also bequeath the fund to loved ones in your will, a benefit not granted to annuity holders.

Anyone choosing to withdraw should be aware that fees may erode the value of the fund. Another risk is that retirees underutilize their pension fund because they fear it will run out.

A smart approach is to use part of your retirement savings to purchase an annuity and let the rest be withdrawn. Those already in withdrawal can use their remaining fund to purchase an annuity, taking advantage of the higher rates.

Look around for the best annuity quote

Those opting for the annuity route should look for the best value plan. Analysis carried out last week by pensions specialist Age Partnership for The Mail on Sunday shows that for a 65-year-old in good health, the difference between the best and worst annuities available is huge – equivalent to £550 a year on a £100,000 annuity purchase.

Samantha Patterson, head of retirement guidance and client engagement at Age Partnership, says: “It’s an incredible time for annuity clients. Rates are going up and more providers are entering the market, resulting in more choice and competition.’

The annuity rates depend on age and health. The older you are when you buy, the better rate you should get. People with poor health or a history of smoking should also benefit from higher paying annuities.

Canada Life, for example, offers a 7.77 percent annuity rate to smokers with a high body mass index (£7,770 a year on a £100,000 annuity purchase).

Meanwhile, Just is willing to pay 8.72 per cent to someone who has had a heart attack or diabetes (£8,720 a year).

Do I have to pay tax on my annuity?

Annuities are not tax-free, so you may be subject to tax if your total retirement income exceeds the tax-free personal allowance. So if the money from your annuity and other sources of income, such as state pension, exceeds £12,571 a year, you will pay income tax.

On income of £12,571 to £50,270 per annum, you will be taxed at 20 per cent. For income between £50,271 and £125,140, ​​the rate is 40 per cent.

There are exemptions. For example, if you buy an annuity that guarantees a certain number of years and you die before it expires, taxes may not be an issue.

Here, if you die before age 75 and the remaining income under the guarantee goes to a loved one, they don’t have to pay taxes on it. But if you die when you are 75 or older, your loved one must pay income tax.