Annuity rates have increased significantly since the infamous “mini” Budget in October 2022, and now nearly a year later annuity providers are announcing record annuity sales.
Is this just a short-term phenomenon or the start of a renaissance for annuities?
As the income from annuities has increased by about 25 per cent over the past year and by more than 60 per cent since the 2020 nadir, it is not surprising that more and more people are purchasing annuities.
Most advisers will be aware that annuities are priced in relation to the yields on fixed interest investments, and the yield on 15-year gilts is a useful benchmark. During the Covid-19 pandemic in 2020, the yield fell to about 0.5 per cent. It is currently about 4.6 per cent.
Using the rule of thumb that for every 100 basis point rise in bond yields we can expect a 10 per cent increase in annuity income. This suggests that annuities should have increased by about 30 per cent over this time period as yields were up by about 300bp, but the benchmark annuity has increased by 60 per cent, which is double that amount.
It is no wonder that annuity sales have increased significantly, since someone looking to arrange a £100,000 annuity can now get about £2,500 a year before tax depending on age and options compared with the 2020 low point.
As the chart below shows, annuities were in decline from 2008 to 2020 before shooting up dramatically in 2022 and 2023.
When considering if this is a flash in the pan or a longer rate trend, there are several important questions.
Will annuity rates continuing to increase?
It is always difficult to predict markets, but with signs that inflation is getting under control yields may have plateaued, so no big swings are predicted. Therefore, it seems annuity rates will move up and down within a relatively narrow band in line with changes to yields.
The big unknown is the outcome of the war in Ukraine, which still has cause to spook financial markets.
Will the image of annuities improve?
I hope so. There has never been anything wrong with the concept of annuities, and they are still the only financial policy that can guarantee a high level of income for life no matter how long that is.
The problem has been low interest rates. Now they are at a reasonable level it is a good time to remind ourselves of the advantages of annuities, including the peace of mind and security that people will not outlive their annuity income.
Will advisers start to favour annuities over drawdown?
Up until recently, the default position for many people wanting to convert their pension pot into income is to take advantage of pension freedoms such as drawdown. But now annuity rates are higher, the investment returns required for a drawdown arrangement to pay the same income are also higher, so the case for annuities is much stronger.
Putting aside the attraction of leaving money to beneficiaries, those who want to maximise lifetime income with peace of mind and security, especially cautious investors, may find annuities hard to beat.
Annuity rates do not move in vacuum and if yields are going up, equities may be going down. This means some people may end up with a smaller pot with which to buy a higher annuity.
My view is that annuities have probably peaked, because the market does not expect many more interest rate hikes. If rates and bond yields start to fall, so will annuity rates.
Therefore, this is an interesting and challenging time for serious retirement planners — should they advise clients to arrange annuities instead of investing in pension drawdown?
This is one of the most difficult decisions in retirement planning. Leaving aside the simple annuity versus drawdown comparison that normally translates into guaranteed income or flexibility and lump sum death benefits, there are a number of important issues to consider; for example, income sacrifice and peace of mind and security.
Putting aside the attraction of leaving money to beneficiaries, those who want to maximise lifetime income with peace of mind and security, especially cautious investors, may find annuities hard to beatIncome sacrifice is an interesting concept. In simple terms, when rates are high, most people who take income by way of pension drawdown probably end up getting less income compared with an annuity.
This means that many drawdown investors are making the decision, consciously or without realising it, to accept a lower income than they could have had in order to benefit from income flexibility, investment control and the option to leave money to their family.
There is nothing wrong with this and very good reasons why drawdown is a good idea, but if the question is reframed and people are asked what they prefer: more money while they are alive and can enjoy it, or less income now and more money to the family when they die — I wonder what the answer would be?
There is another type of income sacrifice where people lose out on income by delaying their annuity purchase in the hope that rates will get better.
Now annuity rates are paying a high level of income and are a viable alternative to pension drawdown, it can be argued that most people should have some annuity in their retirement income portfolios because annuities are the only way to get the elusive peace of mind and financial security.
Billy Burrows is an adviser at Eadon and Co and hosts the Annuity Project
