Last year was a good one for annuities, with rates increasing by about 6% and sales at their highest since pension freedoms in 2015.
So, will 2026 be as good for annuities and what do advisers need to consider in order to give best advice?
The answer to annuity rate trends depends on the bond markets as all good advisers will know they are priced in relation to yields on long dated gilts and the 15-year gilt yield is a useful benchmark.
As the chart shows, annuity rates may have peaked and yields are on a downward trend, so it is likely that annuity rates will end 2026 lower. How much lower is impossible to predict but I don’t expect any dramatic cuts and it is possible that rates may end the year not too far off current levels.
It is important to remember the amount of annuity income is a product of both annuity rates and fund values. If annuity rates fall but pension funds increase, the resulting annuity income may be similar or even higher.
Therefore, advisers and their clients must keep one eye on annuity rates and one eye on fund values. The Holy Grail of retirement planning is to identify times of high annuity rates and high fund values, and then lock into high levels of guaranteed income. Easier said than done.
There is more to this than just chasing the highest rates. Obviously, it is important to secure the highest possible income by taking health and lifestyle into account, but it is even more important to make sure that the right type of annuity is purchased at the right time for the right reasons.
Generally speaking, people with a dependant spouse or partner should consider joint life annuities
There are literally hundreds of different permutations of annuity options but the main options are: single or joint, guarantee period or valuation protection and level or inflation proofing.
Added to this list is the choice between lifetime and fixed term. Fixed-term income plans are not actually annuities but a subset of pension drawdown, but let’s not get too technical!
Generally speaking, people with a dependant spouse or partner should consider joint life annuities. Many people start off by thinking a single life annuity with the highest income is the best option and are surprised to find the reduction for joint life is not as much as they think. The best thing to do is always provide people with a range of options at the outset.
The choice between level and escalating is important but subject to necessity and behavioural bias. Many people simply cannot afford the luxury of inflation proofing (RPI annuities) so the level option is the default for most annuities. This may not be as bad as it seems if the state pension and DB pensions contribute to the largest element of retirement income because these are inflation proofed.
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For those with significant pension assets, inflation proofing is the only no-risk option as inflation reduces the spending power of those with fixed incomes. Intuitively, many advisers and their clients dismiss inflation-linked annuities as poor value for money, but a more thoughtful analysis will conclude they are fairly priced and good value.
For those concerned about the pricing of RPI annuities, especially with the move from RPI to CPI, a sensible compromise may be a combination of RPI and 3% escalation. At the moment, an annuity increasing by a fixed 3.75% per annum provides the same starting income as a fully inflation-proofed annuity.
Who would bet that inflation will stay under 3.75% for the next 20 years or more? Especially considering the saying, “Inflation is like sin: every government denounces it and every government practises it.”
Finally, there’s the guarantee period and value protection. I think it’s logical to use the least amount of money to provide the highest lifetime income but with some insurance against dying soon after taking out the annuity. This means that five or 10-year guarantees make sense but any longer guarantees (e.g. 25 years) erode the benefit of mortality cross subsidy, which make annuities unique.
It may be counter-intuitive but just because rates are high doesn’t necessarily mean it is the right reason
100% value protection is a good option for those worried about dying early. A deep dive into the numbers will show that the benefits from a 10-year guarantee and 100% value protection are similar.
I cannot end the section on options without mentioning enhanced annuities, but I take it for granted that all good advisers take information about health and lifestyles into account when getting quotations.
When is the right time to arrange an annuity? There is no recognised optimum time to purchase an annuity but it seems the average age is increasing. More people are purchasing annuities in their 70s, especially with the looming IHT on unused pension pots, which is resulting in more income being taken from them.
I have been quoted as saying that the right time to arrange an annuity is when people are looking for ‘peace of mind and income security’. This may be at different ages and times for different clients.
Finally, it is important that they are arranged for the right reasons. It may be counter-intuitive but just because rates are high doesn’t necessarily mean it is the right reason.
It is more important to look at other factors, including the need for guaranteed income and the need to de-risk, especially for those in drawdown, and the importance of insurance against running out of retirement income.
William Burrows is the founder of the Annuity Project and a financial adviser with Eadon & Co
