Higher interest rates have boosted the returns on cash savings accounts but the impact on annuity rates has been just as dramatic. Unfortunately, it may soon go into reverse and many people now have a decision to make.
An annuity is the guaranteed lifetime income that almost every pensioner used to buy at retirement, to provide income for their final years.
Before the financial crisis in 2007, somebody with £100,000 worth of pension could get annuity income of £8,000 or £9,000 a year.
That crashed to less than £5,000 after the Bank of England slashed interest rates almost to zero in March 2009, making annuities look rotten value.
This led to a huge campaign against annuities and in 2015, the obligation to scrap one was axed, under so-called “pension freedom” reforms.
Annuity sales collapsed overnight, and today the majority of pensioners leave their savings invested in retirement via drawdown, taking income as required.
Drawdown is flexible and should make your money work harder but it also has risks. If the stock market crashes, your pension is likely to crash with it.
There is also a danger that retirees will deplete their savings long before they die, and have nothing left for their final years.
That will never happen with an annuity, as the income is guaranteed to roll on for as long as you do.
Annuity rates are priced off gilt yields and when the Bank of England started hiking interest rates to battle inflation, they suddenly started to look attractive again.
Emma Watkins, managing director of retirement and long-standing at Scottish Widows, said: “A 65-year-old can now get income of more than £7,200 a year from a £100,000 pension pot, up from less than £5,000 two years ago.”
That gives them an extra £2,200 a year, which adds up to £44,000 over the course of the typical 20-year retirement.
However, the opportunity may soon pass after today’s surprise figure showed inflation falling below five percent.
When the Bank of England starts cutting interest rates again, possibly as early as May, annuity rates will also fall (and most likely beforehand).
Those who are tempted to lock into a lifetime guaranteed income should therefore consider taking action today.
Many will have been holding back in the hope that rates will get higher still, but that now looks highly unlikely.
From here, the only direction is down.
I probably shouldn’t say that. Market movements are almost impossible to predict. Interest and annuity rates could stay higher for longer than markets assume. It just looks unlikely.
Personally, if I was dead keen on buying an annuity, I wouldn’t hang around as they now offer the best value in years.
However, price is not the only factor that should guide your decision, said Laura Suter, head of personal finance at AJ Bell. “Annuities offer a guaranteed income but they are inflexible. Once you have used your pension to buy an annuity there is no backing out.”
READ MORE: Tough annuity choice. Lock into income for life or gamble on drawdown
Drawdown carries investment risk as the value of your pension may rise and fall with stock markets. Yet it is also more flexible and makes it easier to pass on unused pension to loved ones when you die.
It’s not a straightforward tick box decision, then.
Suter suggested a combination of the two might offer the best of both worlds. “Maybe use some of your pension to lock into a guaranteed income for life, while leaving the remainder in drawdown to access flexibly or pass on tax efficiently to beneficiaries.”
There are other factors to consider when buying an annuity, such as whether to buy a single life annuity or a joint policy that would continue to pay your partner an income if you die first.
Also consider other support for dependents, such as a guarantee payment period, which will continue paying income for a short period after you die, or value protection, which pays a lump sum to loved ones.
It’s complex and financial advice may be required. I just wouldn’t hang around wondering whether to take it. For annuities as well as savings accounts, now may be as good as it gets.
