Before 2015, the route to securing retirement income was pretty simple: purchasing an annuity was compulsory before the age of 75. But ‘Pension Freedom’ allowed savers to leave their pension pots invested and ‘draw down’ income as they needed it. Given that this change happened in the wake of the 2008/9 financial crash, which meant that rates were at rock bottom, it’s not surprising that annuities fell out of favour.
But two factors have combined to make some people review that aversion to purchasing an annuity.
The first is that rates have bounced back considerably from their post-crash lows. In 2014, a £100,000 pension pot would secure a level annuity at the age of 65 of as little as £4,500; today, even with interest rates once again on a downward trajectory, the figure is more like £7,700.
The second factor was the Budget announcement by Chancellor Rachel Reeves that unused pension pots will be brought within the scope of inheritance tax from April 2027. Given that joint annuities are free from IHT on the first death, they thus become particularly attractive to couples who are not married.
The result of this has been an uptick in the take-up of annuities. In 2024 the value of annuities sold was £7.4 billion, the largest figure since pension freedom was introduced in 2015. The increase is especially marked when it comes to higher-value annuities: sales of plans worth more than £250,000 rose by almost a third, and of those worth more than £500,000 by more than 50%.
So if you are approaching retirement, or you have already retired but have left your pension pot invested for the time being, is now the time to consider an annuity?
The answer to that question is, as is often the case, very much dependent on your individual circumstances. There is no ‘one size fits all’ answer. But there are some pros and cons of annuities to take into account before making the decision.
The pros first: above all, an annuity gives you certainty. Your income is guaranteed, not subject to the potential fluctuations of the market, and is there for your lifetime (and you partner’s if you choose a joint annuity). You can choose an escalating annuity which provides a income which rises either by a set percentage or by the rate of inflation; you can also opt for an annuity guarantee (typically five or ten years) which means that it continues to pay out should you die during that period; bear in mind that both of these options will reduce the headline annuity rate.
And, as we have seen, joint annuities are free of inheritance tax on the first death, which can be beneficial to non-married couples.
However, there are some downsides. Once you purchase a lifetime annuity, the decision is made and if your needs change, you can’t undo it.
It also can potentially die with you, so there may not be any unused pension pot to leave to your family. In this respect, it is very much like a traditional defined benefit pension.
Increasingly, we are seeing a ‘mix and match’ approach, where pension-holders use part of their pot to buy an annuity to guarantee their basic income needs, but leave the rest of their pot invested to allow them flexibility in the additional income they draw down.
Some who choose to retire before the state pension age are buying fixed-term annuities to plug that income gap until they receive that state pension.
The truth is that even with strong annuity rates, the investment growth available via the drawdown option can be even larger, so for those who do not need to guarantee their income, this can still be an attractive option.
Annuities are increasingly being considered as part of the retirement income mix. It is a complex calculation, and one which should be undertaken with the benefit of expert advice.