If you’ve saved into a pension throughout your working life, you’re likely planning to draw on these funds to provide you and your family with an income in retirement.
One option you may want to consider is using your pension savings to purchase an annuity. Annuity rates are currently reaching the highest levels seen in over a decade, which may now make them an attractive prospect.
So, as annuities start gaining more attention, discover how they work, why you may want to consider one for funding your retirement lifestyle, and a few downsides to take into account before you make your purchase.
Annuities could provide you with a steady income for the duration of your retirement
An annuity is a type of insurance product that offers a regular, guaranteed income in retirement. Offered by insurance companies and some pension providers, you can use your pension or cash savings to purchase an annuity.
In return, the annuity provider then pays you a fixed income for a predetermined period of time, depending on the type of annuity you purchase.
The different types of annuities you could consider include:
- Lifetime annuity – these can be jointly or independently held and will provide a fixed income until your death. Leftover funds typically can’t be transferred to your beneficiaries after you die.
- Fixed-term annuity – pays a fixed income for a predetermined length of time. At the end of this period, you’ll receive a lump sum from the provider called a “maturity value”.
- Guaranteed annuity – pays a guaranteed income for a fixed number of years, regardless of whether the holder dies before the term ends.
These are the main types of annuities, although others are available with varying features, some more intricate than others. For example, some annuities will continue paying a reduced sum to your spouse after you die while others will increase annually in line with inflation.
It’s important to shop around and find one that suits your circumstances and wider retirement plans.
Annuities can be useful for providing guaranteed, fixed income until your death or the terms agreed with your provider.
Of course, it’s often beneficial to consider your retirement income strategies far in advance so you can prepare your finances.
For example, your pension funds may not be instantly accessible, and the withdrawal process may be lengthy. So, preparing early can ensure that you’ll be able to purchase an annuity quickly, so that you’ll have the retirement income you need as soon as you stop working.
With average rates at a 14-year high, annuities may be worth considering
The reason that annuities are starting to catch the eye of people looking to retire is that, according to FTAdviser, rates have increased by 52% in the last nine months.
This rise brings them to a 14-year high, in which a benchmark annuity of £100,000 at age 65 would pay a £6,873 annual income, up from £4,521 at the start of this year.
This is partially to do with rates keeping pace with surging inflation seen in the UK this year – indeed, inflation-linked annuities have also risen 77% over the same period.
With future outlooks of inflation uncertain, further increases could see annuity rates climb higher, too.
The major benefit of an annuity is the removal of risk from your retirement income. By purchasing an annuity, you can be certain how much you’ll receive each month, making it easy to budget around whatever you plan to do for your retirement.
Additionally, you remove the risk of your invested funds losing value. While having your retirement funds invested in your pension means the potential for growth, it also opens you up to the risk of the value of your fund decreasing if markets perform poorly.
A fall in the value of your holdings could potentially jeopardise your retirement plans if your pension falls below the level you need to reach your later-life goals.
Annuity rates are high now, but they could rise further
Another point to consider is that it could be better to phase your annuity purchases throughout your retirement or over a longer period as, while rates might be high now, they could increase in future. There are a couple of key reasons for this.
Firstly, as you get older, annuity rates usually increase. Rates of payment are based on life expectancy and decrease the longer you are expected to live. So, the older you are when you make your purchase, the better the rate you can expect to be offered.
In addition to this, the wavering outlook on the future of inflation rates is clouded at best, and prices could continue to rise in the new year. This means that, by not committing a large sum to an annuity all at once, you could receive a better rate of income if inflation does continue its current upward climb.
While average rates are the highest they’ve been for 14 years, these factors mean you could get even better rates by waiting to make your purchase.
However, if you’re fearful that a good rate might pass you by, purchasing your annuity in stages can get around this. This way, you can still have exposure to current rates, and then use any remaining funds to explore other options for retirement income or purchase another annuity product down the line.
Downsides to consider before you buy an annuity
While the prospect of a guaranteed income in retirement is attractive, there are a few downsides to consider with annuities. For example:
- You can’t change your mind – once you’ve purchased an annuity, you cannot typically undo this decision. You’ll need to be 100% certain that this is the right option for you before you buy.
- There’s no guarantee you’ll live long enough to reap the benefits – with a lifetime annuity, you’ll only receive income while you’re still alive. This means you could die before you receive more in income than you paid for the annuity itself.
- Funds can’t be passed on to your family – while your family will typically be able to inherit your pension, annuity income typically cannot be passed to your beneficiaries. You should factor this in if you were hoping to leave your estate to children or grandchildren to help them be financially independent.
- Invested pension funds could continue to rise in value – while purchasing an annuity removes the risk of your pension funds losing value and affecting your retirement plans, you’ll also give up any potential returns that those funds might have generated. You’ll need to decide whether guaranteed income or potential growth is more important to you.
Make sure you consider elements such as these before you purchase an annuity.
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This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Your pension income could also be affected by the interest rates at the time you take your benefits. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
A pension is a long-term investment. The fund value may fluctuate and can go down, 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.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.