Essential guide to annuities: what you need to know for retirement planning

Why annuities are back in fashion

In an uncertain world, we like certainty. And an annuity can offer just that – a guaranteed regular income for as long as you live, or as long as you need.

Having a regular annuity coming in each month can bring the same sense of reassurance and security that your salary once did. Once you’ve bought a standard level annuity, any drop in interest rates, rise in inflation or fluctuations in the stock market, will have no impact on your income.

According to figures from the Association of British Insurers (ABI), 2023 annuity sales were up 46% on 2022¹. Given that more of us are living longer – and more of us are in retirement than ever before, annuities can seem a good way to de-risk retirement income.

Annuities feel bullet proof, but are they?  

What is an annuity?

Annuities are one way of guaranteeing a regular income in retirement. When you buy an annuity from an annuity provider, using some (or all) of your pension pot, you’re essentially exchanging your retirement fund in return for a secure retirement income – either for life, or a fixed term. So as long as you buy a standard, level annuity, you are in effect taking yourself and your pension investments out of the stock market. You’re trading potential growth for a guaranteed income.

Many buyers use an annuity to cover off basic living expenses, like council tax, water rates, or other household bills.  Then, any other income from investments or ISAs is for fun. To have holidays, indulge your hobbies, visit friends. Things that retirement was made for.  

Is my annuity rate fixed for all time?

If you buy a standard, level annuity, the rate you buy at will remain the same, regardless of inflation, interest rates or the stock market. But – and there’s always a but – that’s not the only type of annuity on the market. You could opt for an inflation-linked annuity, known as an escalating annuity, which will keep pace with inflation, or offer a fixed percentage increase each year.

One thing to bear in mind – and this is where it’s crucial to take professional advice – is that you’ll receive a lower starting income with an escalating annuity compared to a level one.  

Also, annuity rates change frequently, and many quotes are only guaranteed for a limited time. Once you’ve bought, you’ve bought at that rate – you can't usually change an annuity once it's set up.

According to ABI figures, the average age to buy an annuity is 65.1 If you’re buying the annuity in your 70s or 80s, financial advice can help you calculate if an escalating annuity will be worth the extra money.

Can I buy a joint annuity with my partner?

Yes, but a joint life annuity is more expensive than a single life annuity, because the annuity company is essentially underwriting two lives, not one. As a result, they commonly reduce the amount of initial income you receive. If you buy a single annuity, you can’t pass it on to a partner, unless you included death benefits at the outset stipulating that your spouse or civil partner should get the income on your death. Once again, that may lower the annuity rate you’re quoted.

Will my medical conditions affect my annuity rate?

It sounds counter-intuitive, but your age or medical conditions could work in your favour! Anyone shopping for an annuity should first see if they qualify for an enhanced annuity, where insurers look at every aspect of your health and lifestyle before offering you an income rate. Any medical conditions you have could limit your life, and if you’re not expected to live as long, the amount of annuity income you get could be higher.

What happens to my annuity if I die sooner rather than later?

It is possible to include a guarantee period on an annuity. So, for example, if you take out an annuity for life with a guarantee period of ten years but you die after the first year, the annuity will continue to pay out to your designated beneficiary for the remaining nine years.

Guarantee periods can be as long as 30, or even 40 years.

Why it pays to read the small print

Just as cheap flight deals often turn out to have hidden add-ons for inflight services or cabin baggage, a basic annuity can have a sometimes bewildering number of ‘add-ons’. Choosing an escalating annuity, adding on annuity protection or a guarantee period may nudge the purchase price up. Be aware that you don’t need to go with your current pension provider either. If you have your pension with a particular company and they offer you an annuity rate when you come to retirement, definitely speak to your adviser first. It may not be the best rate for you, or your retirement plans.  

Even your postcode may affect your annuity rates – with some sweeping assumptions made about the likelihood of your longevity, depending on whether you live in Glamorgan or Glasgow.

These annuity ‘add-ons’ can broaden your options – but at a price. So, it pays to take financial advice – and shop around.

Do I have to use my pension to buy an annuity?

You can buy an annuity with any funds at your disposal, not just your pension. You could use an inheritance, savings or other investments, but the types of annuities (and add-ons on offer) are broadly the same.

Annuities purchased with funds other than your pension pot are called purchase life annuities and are taxed differently to annuities purchased using pension money. With a purchase life annuity, every payment you get back is partially tax free, as it’s considered a partial return of the money you paid for it. You could for example take out your 25% tax free cash from a pension and use that for a purchase life annuity.

If that’s starting to sound a little convoluted, come to us to work out what will be right for you.

How do I know if an annuity is right for me?

If you’re wondering whether an annuity’s right for you, a good rule of thumb is your attitude to risk. Many of us become more risk-averse the older we get and would rather remove ourselves from the stock market altogether.  

If you’re concerned, too about the amount of IHT you'll pay, buying an annuity could remove a sizeable taxable amount from your estate. Clearly, it also reduces the amount you could leave in a legacy but for many retirees, that’s an acceptable trade off. Alternatively, you may want more financial flexibility as a younger retiree – making drawdown more attractive, so you can stay invested, and just withdraw what you need, as and when.

Why take advice if you’re thinking of buying an annuity

Retirement is a marathon, not a sprint. And you want to know that the choices you make are both suitable and sustainable.  Holistic financial advice can prove invaluable in helping you understand the types of annuities on offer, their differences, and build a retirement plan that works for you – for a lifetime.

Want to speak to one of us about annuities? Get in touch today.

Source

¹Association of British Insurers, (ABI) another post-pension freedoms record for annuity sales

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief is generally dependent on individual circumstances.

You should be aware that annuity rates can change substantially and rapidly, there is no guarantee that when you purchase an annuity the rates will be favourable.  As it is not possible to change your annuity after purchase, this could mean that your pension income may be less than you had hoped for.

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