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An annuity is a product that gives you a guaranteed lifetime income in retirement. It can offer stability and peace of mind, providing a steadily rising income each year to help keep up with inflation. Over the last 7 years since the 2015 Pension Freedoms were introduced, however, annuities have widely fallen out of favour. Typically, they are now used in rare cases such as those directed by court order and situations of impaired life.
More recently, annuities are gaining more attention. Below, our Padiham-based financial planners explain why this is happening and how annuities might feature in a retirement plan in 2022. We hope this is useful and please get in touch if you’d like to discuss your own financial plan with us over a free, no-commitment consultation.
Why has the annuity landscape changed?
In the 1990s, the UK government had started to bring high inflation under control and interest rates started to fall. This was good news for homeowners since the cost of mortgages went down. For annuities, however, this led to lower incomes available in the marketplace. The insurance companies offering annuities tended to invest pension money into lower-risk assets, such as government bonds (gilts). With these assets no longer providing the same returns as in previous years of higher interest rates, insurers were forced to pass the lower profits down to customers in the form of lower annuity incomes.
By the middle of the 1990s, many people were starting to resent paying so much money for low annuity incomes. This helped usher in pension drawdown in 1995 and, later in 2015, full pension flexibility which allowed individuals to keep their pension pot(s) invested and take what they needed for a regular income. With interest rates at historic lows after the 2008 Financial Crisis, annuities were rarely chosen due to the higher (albeit less stable) income that could be attained by going into drawdown.
Now in 2022, there are hints that this situation is starting to change. The Bank of England (BoE) has repeatedly raised the base rate since December 2021 from its all-time low of 0.10% to 2.25% at the time of writing. This means that newly-issued government bonds (gilts) now offer a higher interest rate to investors, such as the insurance companies that offer annuities. Now that higher returns can be attained from “lower-risk” investments like these, these companies can start to pass down higher profits to customers in the form of higher annuity incomes.
Is an annuity now worth it in 2022?
In 2022, a £100,000 pension pot can now buy a 60-year-old an annuity of £4,135 per year. If this person died and wanted their surviving spouse or partner to keep receiving an income from the product, then this person would likely get closer to £3,490. Even with interest rates going up, therefore, it is still debatable whether buying an annuity is worth it – particularly when you factor in rising inflation, which is currently at a 40-year high of 10.1%. If index-linking is factored in, then the annuity rate is effectively halved to £1,620.
Faced with these figures, some may ask why not simply keep the £100,000 pension pot in cash. After all, the savings would not fluctuate with the stock market and would be protected up to £86,000 by the Financial Services Compensation Scheme (FSCS). The risk, however, is inflation. If this averages at the BoE target of 2% per year indefinitely, then a £100,000 cash stockpile might last 40 years if left untouched. However, if the average is close to 4%, then the pot might only last 31 years. At a 6% average, the pot could run out after 26 years. As such, given that many people spend 30+ years in retirement or even longer due to today’s higher life expectancy, keeping a pension pot in cash is typically not a realistic option.
Rather, income drawdown is still an attractive option for most people in 2022. Here, the pension stays invested (e.g. in shares and bonds, which have a higher potential return than cash) and you gradually take money out of the pot – at a “safe withdrawal rate” – to support your lifestyle in retirement. However, an annuity still may have its place in a retirement plan, particularly if you place a high value on having a reliable, stable income. After all, with income drawdown you may need to lower your withdrawals during periods of high market volatility or inflation (to ensure the pension stays sustainable). Those planning on a drawdown approach also need to invest the money wisely. For all these considerations, working with a professional financial planner can be immensely helpful to guide you through the process.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
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