When faced with economic uncertainty, it is often necessary for people to reposition their personal finance priorities from growth to security. So, the potential to achieve both would be a prospect more than welcomed by pension planners.
This would certainly go some way towards explaining why annuities are becoming an increasingly appealing option for retirees.
An annuity is a financial product that someone can purchase with part, or all, of their pension and receive a regular guaranteed income for the rest of their life, or a specified period.
Indeed, with the cost-of-living crisis and high inflation eroding away the real-term value of people’s pension pots, it is understandable why retirees would seek security in the form of a guaranteed fixed income. However, there is now the added incentive of more favourable returns due to a 12-year high in annuity rates.
But what exactly do high annuity rates mean for pension planners?
New life for annuities
Despite renewed interest of late, annuities had fallen out of favour in recent years. Before 2015, they were the primary way for people to fund their retirement. However, the introduction of the pensions freedoms legislation seven years ago allowed savers to access all their pension savings from the age of 55, leading to an increase in more flexible pension products.
Meanwhile, low-interest rates reduced the financial benefits of an annuity. Annuity providers generate returns by buying government bonds, which are, in turn, affected by interest rates. When interest rates are low, annuity rates are pushed down.
However, as we approach the end of 2022, this has all changed – quite dramatically.
In September, the Bank of England increased interest rates for the seventh consecutive time to 2.25% (a hike of 0.5%) in an effort to curb inflation. Accordingly, annuity rates have risen too, and now sit about 35% higher than they were this time last year.
According to Hargreaves Lansdown, this would mean that a 65-year-old with a £100,000 pension pot could now get an annuity income of around £7,000, compared to last year when they would have received £4,900.
Such rates of return would be an attractive option for retirees seeking to secure a fixed income to cover everyday expenses without worrying about the effects of market volatility.
That said, it is important that savers weigh up both the pros and cons, as well as other options that might best suit their current circumstances before deciding upon any financial product.
Downsides to an annuity
E0ven with better rates, annuities are not suitable for everyone. The original issues of inflexibility that pushed them out of favour in the first place still exist.
Indeed, once an individual agrees to receive a regular income at a fixed annuity rate, they are locked in until their contract with their annuity provider ends. This means that their income will not be impacted by any positive market movement or further increased rates. For example, anyone locking in now would potentially miss out on annuity rates that had increased in line with interest rates as high as 5.5% next year, if predictions prove correct.
A lack of growth could result in poor returns in the years down the line – particularly as people are living longer. For this reason, it is important for an individual to factor in their age and health when considering an annuity. A retiree in their late 80s or 90s will likely be less concerned about watching their pension grow, than a 65-year-old who has only recently left the workforce.
Of course, there is no single retirement plan, or product, that works for everyone. So, before making a decision, retirees should seek independent financial advice.
Our qualified advisers at My Pension Expert can assess a person’s individual circumstances and financial position and provide them with personalised recommendations to help them find the financial products best suited to achieving their desired retirement outcome.
For some pensioners, this could well be an annuity, especially if there is an opportunity to take advantage of increased interest rates. However, this won’t suit everyone’s needs. Therefore, seeking advice before making a financial commitment is vital.