Is now a good time to buy an annuity as rates rates hit 14-year high?

Annuity rates have increased by 52% this year. We look at whether now is a good time to buy an annuity

Retirement annuity sign post
(Image credit: Getty images)

If you are thinking about your retirement options, then one question to consider is whether now could be a good time to buy an annuity to give you an income boost in life after work as rates shoot up to a 14-year high.

Retirees who convert their pension pots into annuities can now enjoy much higher incomes as annuity rates reach a 14-year high.

Annuity rates have rocketed by 52% this year, thanks partly to rising interest rates.

A 65 year old with a pension pot worth £100,000 who buys an annuity would now receive a guaranteed income of £6,873 a year, according to the pension provider Canada Life (opens in new tab). This compares to someone who bought an annuity at the start of 2022, who would have only locked in an annual income of £4,521.

Nick Flynn, retirement income director at the pension provider Canada Life, said annuity rates were so good that they are “worth more than just a second glance”. Annuities have previously been out of favour among retirees, but could now be poised for a comeback.

We look at how annuities work, and whether now is a good time to buy one.

What is an annuity?

An annuity is a product that pays a guaranteed income for life in exchange for a pension pot. So, if you had say a £50,000 workplace or personal pension, you could buy an annuity with it, which would pay out a regular income until you die. 

This is in contrast to keeping your pension pot growing in retirement and taking cash from it when you require, a process known as drawdown.

There are different types of annuities - some will pay a higher amount if you are ill or a smoker, some are linked to inflation (so the annual income will rise each year), while others are “joint life”, which pay an income to a spouse when you die. You can also get fixed-term annuities, which don’t pay an income until you die; instead they are just for a fixed period, like 10 years.

Why are annuity rates rising?

Annuity rates are pegged to government bond yields, and these have soared this year. This is partly due to the Bank of England repeatedly hiking interest rates.

It is perhaps one silver lining during a time when homeowners and first-time buyers are worried about mortgage rates, and investors have seen huge turmoil on the markets.

The rise in annuity rates means the break-even point - the point at which you would receive your original pension back through income - has reduced by seven years, falling from 22 years to just 15 years. This means a 65 year old would need to live until age 80 to receive all their pension back as income. 

Inflation-linked annuity rates, in particular, have seen a big improvement over the past nine months, rising 77%. A £100,000 annuity linked to RPI inflation will now pay a starting income of £3,896, compared to one purchased at the start of the year paying £2,195, according to Canada Life.

Most people use drawdown to access their pensions, as this is more flexible, and also because annuity rates were previously seen as poor value.

However, this could be about to change, as annuity rates soar.

Gary Smith, financial planning director at the adviser Evelyn Partners (opens in new tab), adds: “Annuities have become a much more attractive option, particularly for those who value the security of the guaranteed income they offer.”

How do I know if an annuity is right for me?

If you’re trying to work out whether to buy an annuity or use drawdown to access your pension pot, take a look at our handy annuity v drawdown comparison.

If you’re considering buying an annuity as part of your retirement planning, here are some things to think about first:

  • You don’t have to use all of your pension pot to buy an annuity. You could just use part of your pension. And you can mix and match with drawdown. 
  • You can choose what age to buy one. You may prefer to use drawdown to begin with, and buy an annuity later. The older you are, the better the annuity rate.
  • You can continue to pay into your pension after you’ve bought an annuity. This is subject to the usual tax rules - most people can contribute the annual allowance of £40,000 to a pension and benefit from tax relief. 
  • If you have a spouse or civil partner, a joint-life annuity will include a payout for them when you die, which could be 100% or 50% of the income you receive. But the amount you receive will be lower than if you bought a “single-life annuity”.
  • Annuity income is taxable, so make sure you understand how that will affect any potential income tax bill.

Flynn comments: “Clients should look at using annuities alongside drawdown, rather than viewing them in isolation. Phasing annuity purchases throughout retirement means you’ll benefit from better annuity rates as you get older. With the right value protection, you can also ensure your wealth is protected and can be passed to loved ones.”

How do I buy an annuity?

You can normally buy an annuity from your pension provider. However, to get the best rate, you should shop around and compare rates from other providers. There’s a free annuity comparison tool (opens in new tab) from the government-backed MoneyHelper service.

The difference between the best and worst providers can be up to 15% a year extra income, according to research by retirement specialist Just Group. 

If you’re unsure about your options or need advice about buying an annuity, speak to a financial adviser or specialist annuity broker first.

Ruth Emery is contributing editor at The Money Edit. Ruth is passionate about helping people feel more confident about their finances. She was previously editor of Times Money Mentor, and prior to that was deputy Money editor at The Sunday Times. A multi-award winning journalist, Ruth started her career on a pensions magazine at the FT Group, and has also worked at Money Observer and Money Advice Service. Outside of work, she is a mum to two young children, a magistrate and an NHS volunteer.