In some ways annuities are more attractive than they have been for over 15 years as we are in a period of higher interest rates, but the idea of being able to leave a pension pot behind to protect a loved one or pass to the family still has significant appeal.
There are lots of reasons to consider an annuity but the biggest pull of all is the ability to purchase a guaranteed income for life.
This article takes you through what an annuity is, why you might buy an annuity, why they are suddenly appealing, what are the alternatives, why people often choose Pension Drawdown over an annuity, what are Enhanced or Impaired Life Annuities and the importance of shopping around at the time.
WHAT IS AN ANNUITY?
An annuity is a fixed contract bought from an insurance company with cash from a pension pot or from savings that will pay income for the life of the purchaser (annuitant) on pre-agreed terms (this can also be for a defined term). For example, the pre-agreed terms could be with a minimum guaranteed period of 10 years or a reduced income for a surviving spouse or some form of increase in the income payment over time.
Please note that the purchase of an annuity isn’t always just with money saved in a pension pot, it is possible to buy a guaranteed income with savings too. An example might be to provide income for a relative who needs to cover the costs of long-term care.
WHY WOULD YOU WANT TO BUY AN ANNUITY?
Here are the three key reasons why you might want to consider an annuity:
1. Guaranteed Income
An annuity provides a pre-agreed, guaranteed income for life or for a defined term, offering peace of mind and financial security.
2. Longevity Protection
With an annuity, you won’t outlive your savings, as it continues to pay out as long as you live (for a lifetime annuity).
3. Eliminates Most Risks
The alternatives to an annuity are normally to either hold cash or to invest and often to invest in stock markets. Both options come with risks but in particular investment returns are uncertain and some people cannot live with the volatility of being an investor or periods where markets fall.
WHY ARE ANNUITIES SUDDENLY MORE APPEALING?
Insurance companies are obliged to provide a guaranteed income for the annuitant and clearly there is a formula that allows an insurance company to deliver on this promise. It really is all about the maths!
The key factor that influences annuity rates is interest rates (there is a correlation with gilt yields). If interest rates rise the guarantees will be higher and it would be the converse for falling or lower interest rates. At the moment we have seen interest rates rise quickly and so the guarantees now reflect this healthy increase.
WHAT ARE THE MAIN ALTERNATIVES?
There isn’t anything quite like an annuity as nothing else can give you guaranteed income. The rate quoted for an annuity is actually a combination of real income (yield) and some of the capital but the capital is spread over your anticipated lifetime and this is why the income is higher than just the true income.
Cash or deposits offer fixed rates (guaranteed returns) but these are generally for a limited period of time and Pension Drawdown exposes you to investment risk.
WHAT IS AN ENHANCED OR IMPAIRED LIFE ANNUITY?
An enhanced annuity is a standard annuity that takes into consideration important information about your health and lifestyle. For example, someone with a life threatening illness can secure a much higher level of guaranteed income than someone who is expected to leave ten times longer.
The industry now reflects a more nuanced approach and will take into account everything from raised blood pressure to smoking to cancer. Whilst uncomfortable to discuss, it is, of course sensible to secure the best possible income available.
THE IMPORTANCE OF SHOPPING AROUND: OPEN MARKET OPTIONS
If you decide that an annuity might be for you and securing a good guaranteed income would be ideal for your future then it’s vital to explore the open market before purchasing an annuity.
Different providers offer varying rates and terms, so shopping around can secure a better deal and sometimes the difference is significant.
THE BIGGEST RISK TO ANNUITY INCOME
Whilst it is possible to select some inflation protection when buying an annuity it is expensive to do so. It is attractive to secure the highest possible income from outset as many of our financial needs are right now, today, and who knows how long we might live!
However, inflation can have a real impact on spending power and whilst annuities offer a guarantee they cannot protect you 100% against inflation and if you do select some index linking the amount of income that you might receive can easily be significantly reduced at outset.
A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
