A recent FTAdviser report confirms that “annuities are back”. With rates rising to 14-year highs and nearly 1 million pre-retirees currently considering one, this certainly appears to be the case. But did they ever really go away?

If you are approaching retirement, you might be tempted to choose between an annuity and one of the more flexible options introduced by Pension Freedoms legislation. The current climate though, and the already existing ability to take a mixture of both options, makes this binary choice irrelevant.

Keep reading for a look at why an annuity is still a great option, and why combining it with a flexible element could make even better financial sense.

Annuity numbers are rising as pre-retirees seek a stable income amid current uncertainty  

Money Marketing reports that almost 1 million working people in the approach to retirement are considering an annuity for the first time. That number is on top of the 828,000 pre-retirees (over-55s currently in employment) who always intended to take an annuity.

Figures published by FTAdviser back in October 2022 found that annuity rates had increased by 52% from January to September. The rise marked a 14-year high.

Published figures suggest that of those considering an annuity for the first time:

• 16% are tempted by improved rates
• 78% want the stability of a guaranteed income
• 36% like the assurance it offers in a volatile market.

While 44% of pre-retirees stated they wanted a guaranteed income for life, worryingly, only half were considering an annuity, despite an annuity offering exactly that. This suggests that misunderstandings about the product abound.

There are pros and cons to an annuity but advice can help you decide if it is right for you

In the current climate of market volatility, drawdown performance has been poor. This is because the drawdown option leaves your untaken funds invested, and so susceptible to changes in the market.

It is one reason why the stable, guaranteed income of an annuity has become increasingly popular. A known income makes retirement budgeting easier and your regular pension payments could be used to cover fixed monthly costs, like your mortgage or household bills.

There are downsides to consider too, though. These include:

• Inflexibility – Once you buy an annuity you can’t change your mind or alter the basis on which you are paid.
• A purchase price that is locked in – You buy an annuity based on your pension pot value on a given day but markets could rise in the future.
• You might not live long enough to reap the benefits – Current rates mean you’d “break-even” 15 years into retirement. 

You’ll need to think about whether an annuity is right for you. 

Remember that certain benefits can be added, at an additional cost. These include a pension that rises in line with inflation, continues to pay to your spouse on death or provides income for a guaranteed period (even if you die during that time).

You don’t have to choose between a fixed income and pension flexibility

Pension Freedoms legislation allows for greater flexibility than an annuity. You have three main options.

1. Uncrystallised fund pension lump sum

You can take an uncrystallised fund pension lump sum (UFPLS), of which a quarter is paid tax-free, with the remainder taxed at the highest rate of tax you pay.

A lump sum is great for covering one-off expenses but you’ll need to be aware of the potential tax implications. 

Taking a large amount in one go could push you into a higher tax bracket. You might also find you are emergency taxed. Any overpayment can be refunded but this may take time, jeopardising time-sensitive purchases.

This option will also trigger the Money Purchase Annual Allowance (MPAA) reducing your Annual Allowance to £4,000.

Your allowance is the amount you can contribute to a pension while still benefiting from tax relief so bear this in mind if you intend to take funds while continuing to contribute elsewhere.

2. Flexi-access drawdown

Drawdown allows you to take up to 25% of your pension pot tax-free. The rest remains invested and you can withdraw – or “drawdown” – income as and when you wish. The income will be taxed at your marginal rate.

The value of the fund not taken as tax-free cash remains invested. This means it can continue to rise and fall in line with movements in the stock market. 

With this option, you are wholly responsible for your own budgeting so advice will be crucial to ensuring you don’t overspend. 

This option also triggers the MPAA.

3. A mixture of flexibility and annuity

Annuities offer a guaranteed income and current improved rates mean you might opt to take a portion of your pension this way.

You can then use other pension schemes to provide you with the flexibility to make one-off purchases, for luxuries like holidays or house renovations, say.

This “best of both worlds” approach means you can retire in a way that works for you.

Get in touch

The decisions you make at retirement will have implications for the rest of your life so you must get them right. 

With decades of experience, our Chartered Financial Planners have the expertise to help you plan the perfect retirement for you. If you have any questions, please get in touch and speak to us today.

Please note

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.