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Annuities are above 7% but don’t ditch pensions entirely, say experts

20 February 2024

The high rate of interest may not be as alluring as it first appears but annuities can still be a useful tool.

By Jonathan Jones,

Editor, Trustnet

Retirees can get as much as 7.1% per year in income from an annuity at present, data from Hargreaves Lansdown shows, but experts have warned that locking up your pension into the product may not necessarily be the best option.

Typically, those in retirement can sell part or all of their pension to get an annuity, which pays out a guaranteed income each year.

Currently, a 65-year-old with a £100,000 pension can get up to £7,117 per year from an annuity, research from the UK’s largest investment platform highlighted.

Jack Williams, head of pensions and retirement at Hargreaves Lansdown, said: “The days of soaring annuity rates may be behind us for now, but the market remains buoyant with strong interest from people looking to secure a level of guaranteed income in retirement.

“The relative calm we’ve seen as annuity rates have settled in recent months has encouraged people who otherwise may have hesitated to take the plunge (for fear of missing out on a better rate later) to take a look now.”

Those that have cashed in on this high return have done so more aggressively, with the average amount of annuities purchased through Hargreaves Lansdown rising 14% in January 2024 compared to the same period last year.

“We are also seeing people use more of their pension to convert to income. With inflation on the way down and interest rate cuts potentially feeding through in the coming months, annuities look better value,” Williams said.

However, the high rate of interest may not be as alluring as it first appears, according to Peter Hargreaves, financial planner at EQ Investors.

While they are a “reliable source of income”, he warned that the “devil is in the detail”. The figure used above is a single life annuity, meaning the payment is fixed forever.

In 20 years, assuming an average inflation rate of 3.5% per annum, the cost of goods and services would have doubled, meaning that £7,117 worth of products would cost £14,161.

“Suddenly, that seemingly robust annuity income may no longer suffice to cover essential expenses, leaving retirees grappling with financial strain in their later years,” he said.

While there is the option to take out an annuity that offers inflation protection, these are less attractive, with the rate hovering around 4.5%.

This compares poorly when viewed alongside those who invest their cash. According to Invesco’s in-house capital market assumptions for the next decade, a portfolio with 60% in stocks and 40% in bonds will net around 5.6% per year, while global equities are expected to make 6.4% per annum. Meanwhile, global bonds are forecast to make 4.4% a year.

Victoria Ross, chartered financial planner at Progeny, also highlighted another drawback to annuities: inheritance.

“Pension savings can be inherited by children for example, whereas after the guaranteed period on an annuity, there would be no payout available to anyone beyond the spouse, civil partner or other financial dependant, so a non-dependant child could not benefit,” she said.

However, this is not to say they do not have their place. For example, an enhanced annuity, which pays a higher guaranteed income based on a reduced life expectancy, should be considered by someone with a health condition, she noted.

Additionally, “the guaranteed income of an annuity can provide security and peace of mind, as income will continue to be paid for life, regardless of how long someone lives, so can be suitable for someone with a low risk appetite or who has a history of longevity in the family for example,” Ross added.

Retirees do not necessarily have to make a hard and fast choice between an annuity or pension savings; there is a middle ground. Hargreaves suggested that retirees could allocate a portion of their pension towards annuities while keeping non-essential spending in their pension drawdown or investments.

“This hybrid approach not only provides a safety net for essential expenses but also affords flexibility in managing discretionary spending, particularly during periods of market volatility,” he said.

Williams added: “You can slice and dice your pension and annuitise in chunks throughout your retirement, building guaranteed income as your needs evolve while leaving some of your pension invested where it can continue to grow”.

“You will benefit from higher annuity rates as you age and potentially improved enhancements depending on your health.”

Before making a decision, seeking financial advice is recommended, as everyone has individual financial situations, goals and needs, and there is no one-size-fits-all option.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.