The war in the Middle East has had an unexpected consequence for British retirees – it has made annuities worth buying again.
Annuities offer you a guaranteed income in retirement in return for you handing over a lump sum from your pension pot.
This year annuity rates have been climbing as the war in the Middle East has resulted in a spike in gilt yields. Gilts are government bonds which insurance companies tend to buy to fund the income they pay on annuities. So, when gilt yields rise so do annuity rates.
Annuity rates represent the return you will get on your investment.
The rate you get is set when you buy your annuity – so buy when rates are high and you could enjoy the benefits for decades.
When is an annuity worthwhile?
“The key benefit of an annuity is that they offer a guaranteed income for as long as you live,” says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown. “After years in the doldrums annuity incomes have become extremely robust with incomes hovering close to all-time highs.”
The big drawback with annuities is that you hand over a huge pot of money and if you die shortly afterwards, your family may not get it back.
However, recent rises mean the breakeven point on annuities has dropped significantly, according to Canada Life. Back in 2021 it would have taken 21 years for someone spending £100,000 on an annuity to recoup their initial spend. Now it is down to 14 years.
A 65-year-old buying an annuity today could get a rate of 7.4 per cent, according to Canada Life. On a £100,000 annuity, they would get an annual income of £7,373. After 14 years they would have received back their initial £100,000 investment in annual income and any more years would be pure profit.
So, what are the chances you’ll make it to the breakeven point? According to the latest figures from the Office for National Statistics, a 65-year-old woman is expected to live another 21 years, a 65-year-old man should have another 19 years on average.
If you bought an annuity at 65 then the average woman would enjoy seven years of annuity payments after getting back her original investment, or an extra £51,611 at today’s annuity rates. A man can expect five years of extra payments.
What do the experts say?
“A few years ago, buying an annuity was almost unheard of, as rates were so low and the benefits of leaving a pot invested and taking an income via drawdown were clearly evident,” says Rebecca O’Connor, director of public affairs at PensionBee.
“Now, the tables have turned. The probability that the annuity payments represent potentially better value than potential investment gains through leaving a pension invested has increased – especially if you also factor in the security and stability that an annuity represents, compared with the uneasiness of present stock market volatility.”
Annuities are back in fashion and could help you build resilient income in retirement. So, how do you get one?
“Once bought, an annuity cannot be unwound so first you need to take the time to make sure you get the right one for you,” adds Morrissey.
How do you decide if annuities are right for you?
One way to use annuities is to work out your essential living expenses in retirement. Deduct your state pension from that amount as it is another inflation-linked guaranteed income, for now at least. Then you could buy an annuity to cover the rest.
That way your essential costs are covered, while the rest of your pot stays invested.
Start by using a comparison tool such as Money Helper or Annuity Ready. Look at the different types of annuities and the different income you would get. For example, you can get inflation-linked annuities or flat rate annuities. The former will rise with inflation, so rising prices won’t erode your income over time.
Consider whether you need a joint or single life policy. With a joint policy a dependent or partner would continue to receive an income after your death – a single life policy will die with you.
When you are ready to apply make sure you are honest about your health. You may be able to get an enhanced annuity that pays you a higher income so be honest about your smoking, drinking and exercise habits. This is the time your bad habits can be rewarding.
There's also an inheritance tax angle worth considering. From April 2027, unused pension pots will be subject to inheritance tax. Buying an annuity removes that money from your estate — and if the income exceeds your living costs, you could gift the surplus to family free of IHT, provided you make regular gifts from surplus income.
Annuities won’t be right for everyone, but for someone approaching retirement who wants some certainty over their income, annuity rates are more appealing than ever. The war in the Middle East has had many consequences — a better deal for British retirees is an unlikely one, but here we are.
When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
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