Most people with a pension pot tend to have two main options when nearing retirement: go into drawdown or buy an annuity. The former involves keeping your money invested, whilst making regular or ad hoc withdrawals to live on. An annuity, alternatively, involves buying a product with your pension pot which provides a guaranteed regular lifetime income in retirement.
This latter option can have some benefits, especially for those who would rather avoid stock market volatility altering the value of their retirement portfolio. However, for those with a choice, are annuities the best option in 2021? How have recent events and lower levels of interest rates affected annuities? Here at Vesta Wealth, our financial planners in Cumbria, Teesside and across Northern England offer some thoughts on this important topic.
How annuities work – a brief recap
An annuity is a financial product offered by an insurance company which provides a steady income in retirement, until your death. Many can be linked to an index like the Consumer Prices Index (CPI), to help ensure that the value of this income follows the rising cost of living over time. The precise income you get is calculated at the point when you buy the annuity, and this is affected by a range of factors including:
- The size of your pension savings. Naturally, the more money you have to buy an annuity, the higher your income is likely to be in retirement.
- Interest rates. If long term interest rates are high, the annuity payments are also likely to be higher. This is because the insurance company expects to make more profit by investing your money. When rates are lower, however, the opposite tends to be true.
- How old you are. Your annuity payments are likely to be higher if you buy it later, since you are not expected to live as long.
- Payment guarantees. It is possible to buy annuities which only cover you for an agreed period of time (e.g. 20 years), which will typically provide higher income payments compared to one guaranteed to be paid for your lifetime, which may also continue payments to a spouse and children after your death. The longer period your annuity covers, the lower the income is likely to be.
- Additional options. If you only want to cover yourself with an annuity, then it is likely to be cheaper than if you want it to also cover a surviving spouse e.g. joint-and-last survivor.
Why annuities are less popular in 2021
When the government reduced interest rates last year, this also reduced longer term rates, which adversely impacted annuity rates. Whilst this made it cheaper for the government to borrow money to pay for furlough and other support schemes, investors saw lower returns on their fixed-rate investments.
Financial firms offering annuity products needed to account for the lower returns they are likely to get, as a result of lower interest rates. This means that many annuity products in 2021 are offering less attractive income and benefits compared to previous years. Indeed, one study suggested that a 65-year-old may need to wait until age 86 before they get their money back on an annuity.
Should I wait to buy an annuity?
This is a difficult question to answer.
On the one hand, interest rates are at an historic-low. This means you are likely to receive less annuity income compared to, say, buying one two years ago. However, on the other hand, there is no guarantee that the base rate will not fall further at some point in the future.
Of course, the answer about whether and when to buy an annuity is very specific to the person in question. Factors which influence the decision include your wider financial goals e.g. the amount of income you need, whether you want to pass on your pension as an inheritance one day, your attitude to investment risk and also your age. An experienced financial planner can help you survey the full range of options in front of you, providing the information and insight you need to make an informed decision.
Invitation
If you would like to discuss your financial plan and investment strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.