PENSION annuity rates have hit a 15-year high and experts suggest now is a good time to buy one.
Annuities are a product you can buy with your pension pot that gives you a set income when you retire.
1
Exactly how much income you will get depends on several factors including the value of your pension pot, health, life expectancy and circumstances.
Rates change all the time, which can have a huge impact on how much income you get in retirement.
In the past year rates have improved, which has meant the number of people looking for an annuity has soared.
According to the Association of British Insurers, annuity sales rose 24 per cent in 2024.
So should you buy one? Adele Cooke explains if they will work for you and how to get the best deal.
How do annuities work?
Annuities give you a guaranteed income when you retire that will be paid for the rest of your life.
Usually people buy one with money from their pension pot.
When you use cash from your pension pot to buy an annuity, you can take up to a quarter of its total value as tax-free cash.
You can then use the rest to buy the annuity and any income you get is taxed as earnings.
To purchase an annuity you must be aged 55 or older but this threshold will rise to 57 from April 2028.
After you have set up an annuity you cannot make any changes to it.
Once it is up and running you will start to get regular guaranteed payments, which you agree to when you set up your annuity.
Annuities can be a good option for people who want the guarantee of an income for life.
They will pay you the same amount irrespective of what happens to interest rates and in the wider world.
What are the different types of pensions?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (SIPP) – This is probably the most flexible type of pension as you can choose your own provider and how much you invest.
- Workplace pension – The Government has made it compulsory for employers to automatically enrol you in your workplace pension unless you opt out.
These so-called defined contribution (DC) pensions are usually chosen by your employer and you won’t be able to change it. Minimum contributions are 8%, with employees paying 5% (1% in tax relief) and employers contributing 3%. - Final salary pension – This is also a workplace pension but here, what you get in retirement is decided based on your salary, and you’ll be paid a set amount each year upon retiring. It’s often referred to as a gold-plated pension or a defined benefit (DB) pension. But they’re not typically offered by employers anymore.
- New state pension – This is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £203.85 a week and you’ll need 35 years of National Insurance contributions to get this. You also need at least ten years’ worth to qualify for anything at all.
- Basic state pension – If you reach the state pension age on or before April 2016, you’ll get the basic state pension. The full amount is £156.20 per week and you’ll need 30 years of National Insurance contributions to get this. If you have the basic state pension you may also get a top-up from what’s known as the additional or second state pension. Those who have built up National Insurance contributions under both the basic and new state pensions will get a combination of both schemes.
But they are not right for people with complex health issues or a shorter life expectancy.
This is because the longer you live after taking out an annuity the better the return you get on your initial investment.
For example, you could spend £100,000 on an annuity that pays £7,000 a year.
After 20 years you would have received a total of £140,000 – £40,000 more than you paid for the annuity.
But if you lived for just seven years after you took out the annuity then you would have been paid a total of £49,000.
This is £51,000 less than you paid for the annuity.
As the annuity rate is fixed they are not right for people who may need more income in the future.
What are the best rates at the moment?
Average annuity rates for a 65-year-old are currently 7.26 per cent, according to Retirement Line.
This means for every £100,000 you invest you would get £7,260 a year.
In comparison, a typical annuity paid just 4.65 per cent, which is equivalent to £4,650 a year on the same investment.
Andy King, pension technical specialist at wealth management firm Evelyn Partners, said: “Annuity rates have not been as high as today since the middle of 2008.
“There was a short term blip after the Liz Truss tenure when rates reached 7.4% but they then dropped sharply down to just over 6% within a period of 6 months.”
Different providers offer different rates so you should shop around to make sure you are getting the best deal.
Buying an annuity is usually an irreversible decision so you should make sure you are happy with your purchase and are getting the best deal before you commit.
Mark Ormston, of financial planner Retirement Line, said: “The average annual income difference between the lowest and highest offering on the open market was 14 per cent.
“That’s 14 per cent less every year for the rest of someone’s life! This gap increases when health and lifestyle factors are included.”
Scottish Widows currently has the best annuity rate, at £7,442 per annum.
Meanwhile, Aviva would offer the same customer a return of £6,916 a year – £526 less.
Over a 20 year retirement you would be £10,520 worse off with the Aviva annuity.
Some providers offer better rates to customers who are in poor health, such as smokers, those who have a heart attack or suffer from high blood pressure.
This is because they assume you will not live as long so they will need to pay out your annuity for a shorter period.
For example, Aviva will pay smokers £7,922 a year – £1,006 more than non-smokers.
How can I get the best deal?
As you approach retirement your pension provider should send you information about the value of your pot and your options to take money from it.
Some providers can offer you an annuity directly.
But you do not have to buy an annuity from your existing provider.
For annuity advice contact Pension Wise, a free government service that can help you to understand the options for your pension pot.
You can also compare annuities on the Money Helper website.
If you need help choosing an annuity deal then speak to a broker.
Make sure they are registered and do not accept a quote without taking advice first.
