Comparing annuity rates on the open market could boost your income by more than £13,000 in retirement, according to new research by Canada Life.
You can buy an annuity from a wide range of providers, and it will provide you with a guaranteed income either for life, or a fixed term. There are several different types of annuities on the market and it’s important to both choose the most suitable one for you, and get the best rate possible, as an annuity is a once-in-a-lifetime purchase. Read more in our guide Annuities Explained.
Canada Life compared the amount of income provided by an annuity bought by a 65-year-old with a £150,000 pension, with a 10-year guarantee and no health or lifestyle factors. They could receive £10,352 a year from an annuity if they shop around for the best rate compared to £9,690 if they received the lowest rate. Over a 20-year retirement, that amounts to a difference of £13,240 in income.
An annuity guarantee (10 years in this example) is a death benefit that means that your payments will continue to be paid if you die before a chosen period of time. Canada Life added the difference could be greater between the highest and lowest rates given that many annuity providers don’t publish their annuity rates.
It’s vital to remember that you don’t have to choose the annuity offered by your pension provider, and you should always exercise your ‘open market option’, which essentially means you can shop around elsewhere.
In this article we explain why it pays to shop around for your annuity, and how to go about it.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
The benefits of shopping around for an annuity
Annuity rates are affected by several factors, including the yields on government bonds, known as gilts, and interest rates. Annuity rates rose by around 15% in September 2022 after gilt yields rose to record levels following the mini-Budget. After falling from these highs, they have soared again following a series of increases in the Bank of England base rate. As interest rates rise, annuity rates increase, which increases the amount of income they provide.
Nick Flynn, retirement income director at Canada Life, said: “Even in one of the straightforward scenarios, our calculations show the difference in income over a typical 20-year retirement can add up to thousands of pounds. That’s before you factor in health and lifestyle related questions, which can add additional income.
“With the considerable interest from customers seeking to capitalise on annuity rates where they are today, it might be easy to lose sight of some of the simple measures people can take to ensure they extract as much value from their pensions as possible. Seeking help from a specialist annuity broker or advice from an adviser should always be part of any buying process.”
Today, an annuity for someone aged 65, with no pre-existing health or lifestyle conditions, would pay around 7%, said Canada Life.
Bear in mind that annuity income, just like income from a pension drawdown plan, is taxable and must be added to your State Pension and any other income you receive for income tax purposes. You also cannot typically pass on annuity income to your loved ones when you die, unless you buy a joint life annuity that pays out to your spouse or partner on your death, or another beneficiary, such as a child until they reach a certain age.
Buying an annuity (like taking your 25% tax-free cash lump sum) does not trigger the Money Purchase Annual Allowance (MPAA), which reduces the amount you can pay into your pension and benefit from tax relief on, once you start making pension withdrawals. This means that you can continue to contribute up to your Annual Allowance of £60,000 and benefit from tax relief – rather than have this reduced to the £10,000 MPAA.
Choosing an annuity
There are several different types of annuities on offer from a wide range of providers, so it’s important to choose carefully. You can get more income, for example, if you qualify for what’s known as an ‘impaired life/enhanced annuity’ because you have a health condition that is expected to reduce your life expectancy, such as diabetes or heart disease. You may also receive a higher income’ if you are a smoker, or overweight, for example. The annuity provider pays a higher income as it assumes it will make payments for a shorter period of time.
Stephen Lowe, group communications director at Just Group, said: “It is important retirees divulge their medical history and lifestyle factors because that can make a big difference to the amount of income on offer.”
Meanwhile, ‘fixed term’ annuities can be a useful way of producing an income for a set period of time, such as two or three years, until you receive the State Pension. Since you’ll only receive an income for a relatively short period of time, you’ll use less of your pension than you would if you wanted an income that lasts your lifetime. For example, someone at age 57 might decide to use part of their pot to buy a 10-year fixed term annuity to provide a guaranteed income to take them to State Pension age.
You might also want to choose an inflation or index-linked annuity to provide an income that will keep pace with rising living costs. Your annuity income initially will be typically lower than the amount you’d get from a standard lifetime annuity (which provides a fixed level of income), but over time as inflation rises, the aim is that you should end up with a higher level of income.
Find more information on the different types of annuities in our guide Annuities Explained.
Your options at retirement
Annuities became an unpopular way of producing an income in retirement following the introduction of pension freedoms in April 2015, which enabled retirees to do as they wished with their defined contribution pension pot. Annuities offered poor value for money at this point in time as rates were rock-bottom, whereas flexible drawdown offered the potential for investment returns. Read more in our article Your pension options at retirement and What is pension drawdown and how does it work?
However, as annuity rates have risen, so has their popularity. The number of annuities sold rose by 22% in the first three months of 2023, compared to the previous three months, according to the Association of British Insurers (ABI). Between January to March 2023, people bought 16,256 annuities, at a total cost of £1.2 billion, the most spent on annuities since 2015.
Gary Smith, partner in financial planner at wealth manager Evelyn Partners, said: “With uncertainty in equity and bond markets now giving drawdown fans pause for thought, boring old annuities have returned to the radar of many pension savers approaching retirement. Taking an income from investments in drawdown without running down a pot too quickly can be a tricky business, particularly when pensioners’ outgoings are soaring with inflation and depleting savings more rapidly.”
However, you can take a mix-and-match approach to retirement income. For example, you could consider buying an annuity with some of your pension savings and leave the remainder in drawdown, or start with drawdown and buy an annuity at a later date. Bear in mind that fixed-term annuities are available as well as lifetime ones. You’ll want to think about additional annuity options too, as mentioned, such as whether to go for an inflation-linked annuity or add on death benefits for your loved ones to inherit some income when you die.
The disadvantage of buying an annuity earlier rather than later in retirement is that some of your pension savings is used to buy this income, so this money won’t potentially benefit from future investment returns. You might therefore decide to delay your annuity purchase until later. Smith said: “Also, as you age, you may be less inclined to manage the complexities and risks of drawdown and will give more value to the security of a guaranteed income.”
“With this in mind, the plan would be to take an income from drawdown until a certain age (which will vary widely according to individual circumstances), at which point the pot is used to buy an annuity.”
Another option for those who have built up larger pots with a view to retiring early is to buy an annuity to furnish a guaranteed income until the state pension arrives. As savers can purchase more than one annuity over their retirement this does not stop them from also buying one in the later phase.
Where to seek help
If you are unsure how to manage your pension savings, the Government’s Pension Wise service offers people aged 50 and above with free guidance on their pension choices at retirement.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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