Completing the puzzle: Annuity rates are rising at their fastest pace in more than 30 years
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In a new series, we answer YOUR burning money questions…

Should I take out an annuity with my pension savings?

I would like the security of one, but have stayed away because I thought they were poor value.

However, I have been told that rates are improving. A.C. Leeds

Completing the puzzle: Annuity rates are rising at their fastest pace in more than 30 years

Completing the puzzle: Annuity rates are rising at their fastest pace in more than 30 years

Rachel Rickard Straus and Ruth Jackson-Kirby reply: Annuity rates are rising at their fastest pace in more than 30 years – so it is understandable that you would ask if they are finally worth considering again. 

Annuities allow you to exchange a lump sum from your pension pot for a guaranteed income for life. 

They offer the reassurance that even if you live for several decades after retirement, your income will never dry up. 

Even so, until recently annuities had fallen out of favour as the annual income they provide had dropped to all-time lows. 

Now they are on the up again. Average annuity rates have increased by up to 24 per cent in the past year. 

A 65-year-old without any serious health complaints who took out a single-life annuity with £100,000 this time last year would have bought an annual income of £4,905. Today, £100,000 would buy you an income of £6,083, according to annuity expert William Burrows of The Retirement Planning Project – an additional £1,178 every year. 

Rebecca O’Connor, head of pensions and savings at investment platform Interactive Investor, says: ‘Because annuity rates have been low for several years, they had been written off by newly retired people. But the tables may now be turning.’ 

Annuity providers – insurance companies – take your lump sum and invest it to produce an income. 

They tend to invest in bonds as these are low risk and produce a reliable income. But bond yields have been at record lows, limiting the amount that annuity providers can offer buyers as a yearly income. As bond yields have risen this year, so have annuity rates. 

But they are likely to rise further still. That is because the Bank of England is expected to continue to raise interest rates to rein in soaring inflation. As base rate rises, so should bond yields. 

Once you have bought an annuity, it is final – you cannot renegotiate a better rate further down the line. 

Yet, if you want the reliability that an annuity offers, there is a way to do it without relinquishing flexibility. It is buying several annuities at different points in your retirement. 

This gives you peace of mind that you won’t end up in pension poverty, but also means you haven’t locked away all your pension savings in one annuity. 

Helen Morrissey, analyst at wealth platform Hargreaves Lansdown, says: ‘A good strategy might be to annuitise in slices over the course of your retirement. This means you could annuitise a portion of your pension to generate an income to cover your day-to-day expenses while leaving the rest invested so it has the potential to grow.’ 

One option is to take out an annuity that covers your basic living costs for life, and then invest the rest of your pension more flexibly. 

A single person needs around £10,900 for a basic lifestyle in retirement, according to the Pensions and Lifetime Savings Association. 

The state pension gives an annual income of £9,628. Therefore, to make up a shortfall, it would require a 65-year-old to take out an annuity costing £25,000. This would provide an annual income of around £1,400. 

Remember that the older you are when you buy an annuity, the higher the income you should receive. 

If you do go for an annuity, there are several decisions you need to make that will affect your level of income. First, you can choose between a level annuity – which pays out a fixed sum every year – or an index-linked one, which increases your income every year with inflation. 

With inflation soaring at over nine per cent a year, the latter option seems desirable. But they are extremely expensive to purchase. 

If a 65-year-old bought a single annuity with £100,000, they could get £6,083 a year without inflation protection – but just £3,479 a year if they wanted the income to rise every year with the retail price index measure of inflation. 

William Burrows says: ‘For most people, the state pension makes up the bedrock of their retirement income. This, by definition, is protected from inflation. 

‘Therefore, it does not usually make sense to pay extra for an annuity with inflation-protection as it comes at such a high cost. If you find that your income is eroded over the years and you need more income in later life, equity release can be an option if you own your home.’ 

Secondly, you must decide whether you want a single annuity – which pays out until you die – or a joint life one, which will pay out until both you and your spouse die. If the named annuitant dies, the income typically reduces by a third or half. 

Finally, investigate whether you can get an enhanced pension annuity. These pay out a higher income to people who have health conditions – and whose life expectancy is shorter than the average.

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