What role do annuities play in retirement?

Reflecting on the renewed popularities of annuities, Justin Corliss, senior pensions development manager at Royal London, notes that if an individual purchased an annuity in 2021, escalating by either CPI or RPI, they would be “delighted” with the growth in income because of the high rates of inflation.

Corliss adds: “If you didn’t choose escalation, you won’t be delighted as the purchasing power of your income will be reducing significantly. However, if you did choose escalation, it will have greatly reduced your income at outset, though that income will be increasing now. 

“Although this makes annuities seem complex and can be difficult to explain, they shouldn’t be completely disregarded.

"Buying a single life level annuity for those who are part of a couple could still be a bad idea, but people are often drawn to a higher starting income. And that’s why financial advice is key.”

Annuities for peace of mind?

For those clients with a very low capacity for loss and a desire to know absolutely that they will have a certain amount of income, Kirsty Anderson, pensions specialist at M&G Wealth, says an annuity will probably be the best solution for them.

Anderson says: “An annuity gives absolute certainty. You know exactly how much income you’ll receive and you’ll receive this for the rest of your life – unless you’re purchasing a fixed term annuity, which provides a specific level of income for a specific period of time.”

As annuity rates are directly affected by interest rates, the lower the interest rate, the lower the annuity rate, and vice versa.  

And since the global financial crisis of 2008, annuity rates have gradually been reducing to perhaps 4.5 per cent, Anderson explains further.

Fear and a lack of understanding of financial markets are still likely the biggest reasons for the purchase of annuities.Dominic James Murray, Cameron James

“This means for every £1,000 you have in your pension pot, you’d get an annuity payment of £45,” she adds. “The risk of tying into an annuity rate at this level is that once you’ve purchased an annuity you can’t change it.

"There is the possibility that interest rates and therefore annuity rates will increase in the future or that investment markets will provide a greater return.

“The average annuity rate for 2023 is 6.7 per cent, which means that for each £1,000 of savings, you’d get income of £67. So it’s very attractive now for those clients who want certainty over income and are not comfortable with the risks associated with investing.”

The increase with inflation has also made clients become more nervous. With a set income, an annuity can give them peace of mind.