The mention of annuities can transport many people back to the 1990s. A once much used part of pension planning, annuities have declined in popularity over recent years due to low interest rates. Whilst these products should be appealing, guaranteeing a level of income for life, low rates have meant people would have to part with a significant amount of cash from their pension pot to get an acceptable income.

However, with the rise in interest rates, annuities are becoming popular once again and could provide a viable option for those looking to secure a guaranteed income for life as part of their retirement income strategy.

Why are annuities becoming popular again?

To provide an annuity, insurance companies invest money into more “traditional” investments (bonds, gilts, mortgage-backed securities etc.) to generate returns needed to pay the income. For the purpose of this piece, we will refer to these “traditional” investments as “bonds”.

Simply put, bonds have a bond price and a bond yield. Price is the face value of the bond and yield is the return on the capital you invest in a bond.

To look at why annuity rates have increased, we first need to look at the relationship between bond yields and interest rates. Simply put, as interest rates increase, so do bond yields. We have seen the Bank of England drastically increase interest rates in an attempt to stem the UK’s inflation rate throughout 2022. This increase has been reflected in bond yields.

Bond yields share another positively correlating relationship with annuity rates – again, both go hand in hand. It is said that an increase of 1% in bond yields, means around an 8%-10% increase in annuity rates. So, the significant increases to interest rates felt this year, have pulled up bond yields and in turn annuity rates.

The question then remains – what does this mean? Well, a higher annuity rate means a greater level of income provided for a set level of capital. An annuity rate of 3.5% would give an individual with £100,000, £3,500 per annum; an annuity rate of 5% would give the same person £5,000 per annum. The higher the rate, the higher the income.

This is seen throughout the annuity market. According to research published by Standard Life in November 2022, annuity rates have climbed by approximately 50%, reaching a 14 year high in October 2022. Looking at an example, an annuity rate for a healthy 65 year old at the start of 2022 was 4.66% – by the second week in October, this rate has increased to 7.04%*

Still a far cry from the annuity rates available in the mid-90s, these rates are still a welcome opportunity for those suitable individuals.

Is an annuity right for me?

An annuity is a secured income for life which provides individuals a level of certainty, without being subject to the vagaries of the investment markets. This can be an attractive proposition for those with a lower risk appetite, low capacity for loss and a general concern to investment volatility. The downside of an annuity is that for all the security, you’re forgoing the degree of flexibility in current personal pensions.

There are numerous types of annuities and a plethora of features which can be attached, all of which have pros and cons. The question needs to always be asked with any plans or product: “will it suitably meet my objectives?”. Consider “will an annuity meet my income needs throughout my retirement?”; “am I concerned about inflation?”; “do I want to provide a legacy to my family?”. These conversations are all vital when deciding any retirement income plans.

Retirement income planning can be a difficult time and the discussion surrounding annuities is no different. As always, your advisers at MPA will consider annuities when it comes to your retirement plans and are happy to have in depth discussions about this topic. Please do get in touch with your adviser to discuss annuities or any other topics of interest.