As consumers approach retirement, they are faced with a choice about what to do with the money they have saved into a pension scheme. In the UK, one of the main choices is between an annuity and a pension drawdown.
Pension drawdown is the most popular choice, but annuities can also play an important role in establishing an individual’s retirement income. Annuities are financial products offered by insurance companies that provide regular payments to the annuitant (the person who purchases the annuity). Drawdown on the other hand is where your pension savings remain invested, and you withdraw from the fund whenever you choose.
There are a number of benefits of an annuity:
- Guaranteed income level. Annuity payments are often usually fixed and predictable. This can help retirees plan their expenses more effectively and reduce the uncertainty associated with market fluctuations that can impact drawdown investments.
- Currently favourable annuity rates. UK annuity rates (and therefore annuity income levels) rose in 2022 and have stayed high into 2023. In July 2023 for example, annuity provider Standard Life reported that rates for a 65-year-old had risen by 48% compared to where they were at the start of 2022. That rate increase meant that £100,000 of pension savings could now deliver an annuity income of £7,115 a year, compared to £5,888 in June of 2022.
- The option of lifetime income. With a lifetime annuity, you know that you will receive your income until you die, no matter how long you live. There is no risk of your money running out. This can provide a sense of financial security, especially for those worried about outliving their savings.
- Investment risk management. Annuities can provide a way to transfer some investment risk to the insurance company. The insurance company assumes the risk of managing the investments and ensuring that the annuitant receives consistent payments, even if investment markets perform poorly. This may be especially attractive if you do not have the confidence, desire, or time to manage your own investments.
- Product flexibility. There are several UK annuity providers, and across their product range are a number of different types of annuities, and optional features. For example, you can choose between a lifetime or fixed-term annuity, add death benefits to your plan, and take payments on an escalating basis to reduce the impact of inflation on your income.
Of course, annuities are not suitable for everyone and there are disadvantages. These include being locked into your choice, even if your circumstances change in the future. You also won’t benefit from any improvements in the stock market or rising interest rates (although you also remove the risk of poor performance affecting your income).
Individuals considering annuities should thoroughly research and understand the specific terms of the contract and how they align with their financial goals. If you are investigating the suitability of an annuity for your retirement income, you may wish to use the UK government-backed Pension Wise service that offers free guidance to over 50s. Another useful source of information is the What is an annuity? guide from leading UK annuity brokers Retirement Line.
Interesting Related Article: “The Art of Maximizing Annuity Rates: Strategies for Financial Security“