The Bank of England recently increased interest rates for the 12th time in succession, meaning the base rate now stands at 4.50%, the highest rate since 2008. As we know, this is good news for savers but bad news for those with borrowing.
Another key area impacted by changes in interest rates is annuities. Here we take a look at what an annuity is, and why this market has seen something of a sales boom over the past couple of years, largely driven by interest rate changes.
What is an annuity?
Traditionally seen as the option individuals will take when accessing their pensions at retirement, an annuity allows you to give up some or all of your pension (or other capital) in return for a guaranteed income for life.
A combination of historically low annuity rates (i.e. income payable per £ of capital), and the introduction of the pension reforms in 2015, has seen the numbers purchasing annuities falling significantly, with many instead choosing to access their pension more flexibly via drawdown.
But annuities have seen something of a renaissance over the past year or so, with sales increasing 13% during 2021/22. So why is this?
What has happeded to annuity rates?
There are a number of factors that will influence the income an annuity provider will pay you (i.e. annuity rate), including your age; health; purchase amount, but most of all, the rate will depend on underlying interest rates. This is because annuity providers will often buy government bonds with the capital to secure reliable returns for their customers. When interest rates go up, bond returns do also, which in turn boosts annuity rates.
Interest rates have been at historic lows for the past decade so, and this, combined with the additional flexibility within pensions, has seen the annuity market fall considerably. However, with the significant increase in interest rates over recent months, annuity rates have jumped over 50% reaching 14 year highs.
What benefits can I include in an annuity?
In addition to providing you with a guaranteed income for life, it is possible to include further benefits within an annuity. This includes a pension for your spouse should you pre-decease them; linking the income to inflation; and a guarantee period to protect some of the capital, meaning you can tailor an annuity to meet with your circumstances and objectives.
Is an annuity the right choice for me?
The main attraction with annuities is the guaranteed income that they will provide, both to you, and potentially your spouse, and with rates at highs not seen since in over a decade, they are arguably a more compelling option than they have been for many years.
However, despite the significant increase in annuity rates, their inflexibility and drawbacks remain. The decision to purchase an annuity is an irrevocable one, meaning once this has been purchased, there is no way of changing to an alternate option. This is in contrast to drawdown, where you can enter drawdown and subsequently change approach to purchase an annuity at a later date.
In addition, whilst it is possible to include certain benefits for your family to provide some protection for your capital, such as a spouse’s pension or a guarantee period, this will likely reduce the income the annuity pays you. In addition, there is no way of protecting all of the capital, meaning when purchasing an annuity there is always a risk that you could receive back less than the capital used to purchase this.
Summary
In summary, with interest rates perhaps beginning to reach their peak, annuity rates are likely to follow a similar trajectory, meaning they too may be at or close to their peak. As such, for those in retirement or considering their options in retirement, now could be a good time to review the option of purchasing an annuity. Please contact our Financial Planning team today to discuss your retirement planning.