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An annuity is a financial product which offers a guaranteed income over an individual’s retirement. In 2023, annuities have become more popular due to higher incomes offered by new products. Is now the time to buy one?
In this article, our Burnley financial planners explain how annuities work, why incomes are offering better rates in 2023 and how annuities could fit into a person’s wider retirement plan.
What are annuities?
An annuity is typically offered by an insurance company to people who are looking to generate an income from their pension pot.
For instance, suppose an individual uses £100,000 from his pension pot to buy an annuity. The product then provides a £7,000 annual income to him in retirement.
Different types of annuities exist for different purposes. For instance, a “level” annuity typically offers the same income each year across the product’s lifetime.
By contrast, a “rising” annuity will offer an income which rises each year – perhaps at a flat rate (e.g. 5%) or in line with an official inflation measure, such as the Consumer Price Index (CPI).
Why are annuities more popular in 2023?
Annuity sales rose by 22% in Q1 2023 compared to Q4 2022, with 16,256 purchases between January and March 2023. This is, in large part, due to higher rates offered by new annuities.
In mid-May 2023, for instance, a 65-year-old with a £100,000 pension could buy an annuity providing £7,027 per year. By the end of the month, such a person could find deals offering £7,144 as markets anticipated the Bank of England’s next rise in the base rate (in June).
This figure is 20% higher than the same time last year. Annuity rates are highly impacted by interest rates. When the latter goes up, the former tends to do so too.
Successive increases to the base rate helped annuity rates reach a 14-year high in March 2023. With the base rate expected to rise later in the year, annuity rates could go even higher.
Should I buy an annuity now that rates are higher?
Buying an annuity is a very personal decision and its suitability will depend heavily on your financial goals and circumstances – not just the wider economic climate.
Certainly, however, higher interest rates in 2023 justify taking a closer look at annuities if someone is considering his/her retirement options. One benefit of annuities is that they offer high predictability over a retiree’s future income, providing a lot of peace of mind and stability.
Level annuities typically provide a higher initial income compared to other types. However, you should consider the impact of future inflation on your spending power. If inflation rises by 2% each year, for instance, then by year 10 your annuity income would lose 20% of its value.
An inflation-linked annuity can help your retirement income keep up with the rising cost of living. However, if inflation falls in the future, then your income will also fall in line with it.
When buying any annuity, a key issue to consider is your potential lifespan. For example, suppose you use £100,000 to buy an annuity providing £7,144 per year. You would need to live 14 years for the income to start generating a return on your investment.
One option to mitigate this investment risk is to consider adding “value protection” to an annuity purchase. For instance, if you buy a £100,000 annuity and only receive a total of £30,000 in income before you die, then your loved ones could receive £70,000 as a kind of death benefit.
It is important to note that you do not need to use all of your pension pot to buy an annuity. One idea could be to buy a small annuity (e.g. to cover essential retirement costs) and keep the rest of your pension invested, giving you more flexibility over how you take an income from it later. You could even buy other small annuities in the future if you wanted to.
Be careful not to rush into an annuity purchase. Once you buy an annuity, you cannot “return” it like you can with retail products. Consider shopping around for deals on the wider market. Staying loyal to your current provider may not offer you the best rates.
Consider seeking professional advice about how buying an annuity could affect your tax plan. Annuity income is liable to income tax. If you die before age 75, your loved ones can usually receive a value-protected lump sum without a tax liability. If you die after age 75, however, then the death benefit will be taxed at the recipient’s highest marginal rate of income tax.
There is no guarantee that the Bank of England will raise interest rates again when it next meets in to 2023. However, if it does (as widely expected), then new annuities on the market are likely to receive a boost. Speak with your financial adviser if you want to explore your retirement income options.
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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