Improved annuity rates have put these once out-of-favour retirement products back in the spotlight. For retirees, the advantages are clear: secure income and peace of mind. While the latter may feel particularly prized at the moment amid ongoing market volatility, annuities also have their drawbacks. Working out if they are the right option for you requires some thought.
Annuity rates and interest rates are closely correlated because annuity providers invest their money in fixed income securities. In recent years, as the table below shows, rising interest rates and the accompanying rise in gilt yields have boosted annuity rates.
The rise in gilt yields seen over the past month could well lead to higher annuity rates. For that to happen, however, the yield spike will need to be sustained over a longer period. Current figures indicate little change over the past six months: Hargreaves Lansdown calculations from 18 March indicate a 65-year-old could purchase a single life annuity with a five-year guarantee that would provide them with £7,712 per year for £100,000. Last September, that same £100,000 would have secured them an annuity with a yearly income of £7,793 per year.
How external factors impact annuity options
However, interest rates are not the only thing that influences rates. When it comes to evaluating the annuity options available to you, your health and age, as well as whether you want additional features such as a joint-life annuity or an inflation-linked annuity, will all have an impact. Prices can also vary across different providers, so it’s worth shopping around.
If you have certain health conditions such as high blood pressure or diabetes, or if you are a smoker, you might be able to buy an enhanced annuity. The selling point is that these products offer better rates than standard annuities. However, many people forget to flag these conditions at the point of purchase. Just Group estimates that two-thirds of buyers could qualify for higher rates if they disclosed their health history.
The perks and pitfalls of annuities
Annuities don’t suit everyone. However, for some pensioners they have a number of benefits. For a start, they offer guaranteed income for life, and you do not have to worry about actively managing your investments throughout your retirement.
Emma Walker, director at annuity broker Just Group, said: “Political and economic turbulence are a reminder that peace of mind has a value, especially for retired people who often need the income now and can’t wait for better times.”
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If you purchase a joint-life annuity, it will also provide continued income for the other annuity holder if you die first – and this status will not be affected by upcoming changes to the inheritance tax (IHT) regime.
Justin Corliss, technical and pensions expert at Royal London noted: “From April 2027, when pensions become subject to IHT, the survivor benefits from a joint-life annuity will not be subject to [the tax].”
However, annuities are not without their problems. For one thing, they are inherently inflexible. Once you’ve purchased an annuity, you cannot undo that decision. You also lose control over when you can access your money. For example, if you are planning a big renovation one year, you can’t dip into next year’s income to cover costs.
By contrast, with an investment portfolio you can adjust both your withdrawal strategy and your investment strategy depending on personal circumstances, market conditions or inflation.
The total return you get on your investment will also be highly dependent on your life expectancy, although higher rates have made it easier to break even. There is still a possibility, however, that an untimely death could mean you put in far more than you get out.
To protect against this, you could opt for a value protection annuity. This involves the original sum you paid for the annuity (minus any income you received) being paid to your beneficiaries if you die before receiving it back as income.
This is often an overlooked option. In 2024-25 just 7 per cent of annuities were sold with value protection, according to Just Group. While this option does reduce the size of the payouts you will receive, it is not a significant reduction. For example, a 60-year-old purchasing a 100 per cent value protection annuity would receive £268 a year less than if they had bought an annuity without it. However, the reduction in income does increase if you buy a value protection annuity when you are older.
However, bear in mind that, in contrast to a joint annuity, value protection lump sums will be included within a person’s estate once the 2027 pension IHT changes come into effect.
How to blend annuities and drawdown
If you’d like a measure of security but don’t want to lose the freedom of managing your investment portfolio, another option would be a blended approach.
Here, you would use part of your pot to purchase an annuity. This could cover your core living expenses and would sit alongside your state pension as a source of guaranteed income. The remainder of your pot could stay invested, giving you the option to draw down from it for discretionary spending.
Keeping some of your pot invested also provides inflation protection. While it is possible to buy an inflation-linked annuity, these tend to be more expensive. Investing in equities typically provides better protection against price growth.
Corliss added: “If you choose a level annuity that does not increase each year, the buying power of the income will fall over time due to inflation. Even a relatively low inflation rate of 2.5 per cent could halve the buying power of a level annuity over 25-30 years.”
An alternative approach would be to switch to an annuity later in your retirement. During your early retirement years, you could maintain your pension portfolio and opt for drawdown to meet your income needs. When you get older, and if you no longer feel you want the responsibility or pressure of managing your investments, you could purchase an annuity instead.
