Annuity returns return

Has The Bank of England’s steady march of interest rate hikes this year provided a new lease of life for annuities?

Average annuity rates have a hit a 14-year high, having increased by 52% in the past nine months, according to new data from Canada Life. This means the break-even point, the point at which you would receive your original pension back through income, has reduced by seven years, falling from 22 years to just 15 years.

Annuities have long been the forgotten choice of retirement options since the introduction of pension freedoms in April 2015.

Prior to that date, most people with defined contribution pensions were required to buy an annuity with their pension pot when they retired.

But the changes introduced by then chancellor George Osborne hugely broadened the options at retirement, and retirees embraced their newfound freedoms enthusiastically.

Many took the chance to cash in pensions (often smaller ones) entirely; the latest FCA data shows that 56% of policies accessed for the first time between April 2018 and March 2020 were fully cashed in.

A further 29% were put into income drawdown, which enables retirees to leave their pensions invested while receiving a regular income from them.

This growth came at the expense of annuities: just 16% of policies were used to buy an annuity in 2015-2018, and that fell further to 11% over the following two years.

With rates for a level income for life at age 65 hitting an all-time low of less than 4.7% in August 2016, they were widely regarded as dull, poor value and inflexible.

At the same time, global stock markets were enjoying a prolonged bull run and income drawdown seemed like an obvious choice for most younger retirees.

Rising annuity rates have coincided with dramatically deteriorating stock markets this year, and the upshot is that annuities are looking more attractive.

That is in part because interest rates are higher but also because the alternatives look much less alluring.

A benchmark annuity of £100,000 at age 65 would now pay a guaranteed income of £6873 a year. This compares to £4521 at the start of 2022.

Inflation-linked annuity rates have also seen a significant improvement over the last nine months, with rates improving by 77%.

A benchmark £100,000 annuity linked to RPI will now pay a starting income of £3896, compared to £2195 at the start of the year.

Comment

So is now the right time to consider an annuity?

We’d need to look back to before the financial crisis of 2008/9 to see annuity rates at a similar level as today, so from that perspective, it certainly seems like a good time.

Also, with the right guarantees and value protection options, annuities can once more attempt to give drawdown a run for its money.

Those planning retirement or looking to de-risk investment portfolios could therefore sensibly take a fresh look at annuities.

You may also consider using annuities alongside drawdown, rather than viewing one or other in isolation. Phasing annuity purchases throughout retirement can not only de-risk your retirement journey, but you can also benefit from better annuity rates as you get older.

And in the current economic climate, where else could you receive an almost 7% risk free income in retirement?

Of course, the return from an annuity may be risk free but it does come at the sacrifice of capital. With the right value protection, you can ensure your wealth is protected and can be passed on, but that protection comes at the expense of the initial level of income.

With 3-year fixed cash rates now pushing 5%, 7% annuity rates with loss of capital start to lose their appeal.

Annuities are most appropriate for lower risk investors and it is lower risk portfolios that have suffered most recently. If interest rates continue to rise as predicted, it may be more appropriate to wait for portfolios to come back and take advantage of even higher rates in the future, be that from cash, or annuities.

Of course, these factors are never inevitable, gilt yields could reverse and rates start to fall, so if you would like to understand what level of annuity your pension fund could provide now then please get in touch.