Annuities back on the pensions radar and rates are ticking up - but for how long?

Annuity rates more favourable after inflation shock: Five key issues around choosing an annuity


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Published: 08 Jun 2023 Updated: 08 Jun 2023

Pension savers could be seeing ‘boring old’ annuities back on their radar, as annuity rates rise again after the recent UK inflation shock. 

Annuities are a product sold by insurers that guarantee an annual income in return for a lump sum payment, and annuity rates – the amount of income per year you get for a certain lump sum - are linked to bond yields and interest rate expectations. 

The unexpectedly sticky inflation readings for April – 8.7% headline and 6.8% core - set the cat amongst the bond market pigeons, with investors suddenly betting that the Bank of England would keep rates higher for longer. Two-year bond yields rose above 4.5% for the first time since the tumultuous aftermath of the Truss and Kwarteng mini-Budget in September 2022. 

As first-time buyers and mortgage borrowers look on in dismay at the havoc wreaked in the home loan market, Gary Smith, Partner in Financial Planning at wealth manager Evelyn Partners, says one constituency might be feeling less aggrieved – those considering what to do with their pension pot: 

“While annuity rates are not experiencing the sudden surge they did last autumn, they are starting from higher levels maintained since then, and this could present an attractive buy-in point in the coming weeks and months for those who are seeking to secure income from their pension pot in the form of an annuity. If inflation ceases to surprise and does pull back as expected, these annuity rates could be shortlived.” 

As annuity rates are determined by gilt yields, they have improved markedly as the Bank of England hiked the bank rate from 0.10% in December 2021 to 4.5% currently. That means that over the last year or so a saver has been able use a lump sum from their pension pot to lock into higher annual incomes than have been available since rates hit rock bottom after the financial crisis. After pulling back a bit from last autumn’s peaks, annuity rates are now on the up again as inflation worries have pushed up forecasts for bank rate. 

With a £100,000 lump sum a 65-year-old retiree can now buy a level single-life annuity that will provide an income of about £7.017 a year. That compares to £6,614 in February, although it is still below the £7,586 that was very briefly on offer at the post-mini-Budget peak last October. At the start of 2022, however, the same annuity purchaser would have got about £5,000, which means annuity incomes are 40% higher now. 

Looked at another way, if the 65-year-old lives to the average life expectancy for a healthy person of that age, which is about 86, then the annuity purchaser will get a total of £143,357 in income for their £100,000 outlay - rather than the £105,000 they would have got in January 2022. Alternatively, the 65-year-old would have to live for just over 14 years to recoup their annuity outlay. 

Sales of annuities have already been on the increase, surging 22% during the first three months of 2023 according to the Association of British Insurers. Between January to March 2023, people bought 16,256 annuities, with premiums for the quarter totalling £1.2 billion - the highest value since 2015 when pensions freedoms were introduced. 

“Annuities became very much the poor cousin to drawdown for the majority of savers accessing their pension pots when pension freedoms were introduced in 2015,” says Smith. “Not least because interest rates and therefore annuity rates were at rock bottom, making annuities a poor-value option for many. Also equity markets were in the middle of a 12-year bull run, and bond markets very stable, making drawdown attractive.” 

“With uncertainty in equity and bond markets giving drawdown fans pause for thought,” adds Smith, “boring old annuities have returned to the radar of many pension savers approaching retirement. Taking an income from investments in drawdown without running down a pot too quickly can be a tricky business, particularly when pensioners’ outgoings are soaring with inflation and depleting savings more rapidly.” 

Fortunately, says Smith, it’s not an either / or choice.  

“A saver can use part of their pension pot to buy an annuity and leave the rest in drawdown – or can begin with the whole pot in drawdown and buy an annuity at a later date. A greater income will be obtained if the annuity is bought when rates are high as at the moment, but even that isn’t necessarily a headache as more than one annuity can be purchased over the course of a retirement, and fixed-term products are available as well as lifetime ones. 

“Things get even more complicated when deciding on further options like whether to pay extra for an inflation-linked annuity and whether to add on death benefits for family – and it’s these sort of calculations that can really benefit from expert advice, not least because they should be viewed in the context of one’s overall financial set-up. 

“As the market volatility of the last couple of years has exposed savers to the rockier side of drawdown, with many fund values suffering, it should also remind them of the wisdom of gradually building up a cash or cash-equivalent reserve in one’s pension portfolio before retirement becomes a live issue. This gives them more leeway to absorb stock market shocks while they use the cash to either live on or buy an annuity.” 

Pension annuity income, just like drawdown income, is taxable and must be added to the state pension and any other income for the purposes of income tax liability. 

Smith recommends considering a few factors when evaluating when and if an annuity might be a good idea. 

  1. How much do you value the security of a guaranteed income? Annuities are in part a matter of preference: some people put a higher value on the guaranteed income they provide and are less keen on the possible fluctuations of a drawdown pot. For them, apportioning a larger portion of their pot to an annuity makes more sense, particularly at a time of favourable rates. They might for instance want to establish a required guaranteed annual income level, take away the state pension and any other income, and set the annuity to make up the difference.
    Others however will find annuities too restrictive, as a fixed one-off deal, and prefer the flexibility and control of drawdown – at least in early retirement.  


  1. There could be a ‘good age’ to buy one. Another strategy is to ‘flex first and fix later’. The disadvantage of purchasing an annuity early in the retirement phase is that a chunk is taken out of the pot that could go on to earn investment returns. Moreover, as a retiree gets older they may be less inclined to manage the complexities and risks of drawdown and will give more value to the security of a guaranteed income.
    With this in mind, the plan would be to take an income from drawdown until a certain age (which will vary widely according to individual circumstances), at which point the pot is liquidated for an annuity. 


  1. A ‘surrogate state pension’? Yet another option for those who have built up larger pots with a view to retiring early is to buy an annuity to furnish a guaranteed income until the state pension arrives. Someone at age 57 could use part of their pot to buy a 10-year fixed term annuity to provide a guaranteed income to take them up to state pension age, while drawing additional funds if needed from the remaining invested pot. As savers can purchase more than one annuity over their retirement this does not stop them from also buying one in the later phase.
    Such considerations might become more commonplace if the higher annual and scrapped lifetime allowance measures announced in the last Budget remain in place. 


  1. An annuity does not trigger the money purchase annual allowance. Just like the 25% tax free lump sum, purchasing an annuity does not trigger the money purchase annual allowance. This means that you can continue to contribute the annual allowance of £60,000 to a pension and benefit from tax relief – rather than have to submit to the £10,000 MPAA.


  1. Passing on of wealth. It should be noted that funds held in a defined contribution pension pot do benefit from being exempt from inheritance tax. This for some savers means that it might be preferable to keep the pot in drawdown rather than using a lump sum to buy an annuity, A standard annuity dies with the policy holder.
    But it is possible to include options with an annuity that can protect your family on your death, although adding such benefits for the same purchase sum will reduce the level of starting annuity you can receive. These can include an income for spouse or partner, on your death, that could be 100% or 50% of the pension you receive. Any ongoing annuity received by a spouse or partner would be free of income tax if death occurs before age 75, but taxable if death occurs post age 75.
    Where the annuitant wants to provide some protection for their children / grandchildren, they could include a guaranteed period, and this will ensure that the annuity is paid for a set period of time, regardless of whether or not they survive this period. If death occurs pre-75 this is typically paid free of tax, with tax paid on death post age 75.