Before the Pension Freedoms legislation of 2015, people typically purchased an annuity when they reached retirement age, as it provided a guaranteed income for life. When the legislation came into force this changed, as it allowed retirees to access their retirement fund in a more flexible way.
For example, they could withdraw a smaller income from their pension pot to begin with if they wanted to work part-time. If you’re considering this, you might want to read our informative blog about a little known tax trap that you may fall foul of.
While in recent years annuities have fallen out of favour, this may be changing. Read on to find out how annuities work, the benefits they could offer, and why you might want to consider them as part of your retirement strategy.
Before you do, let’s look at the Pension Freedoms legislation and what it meant for annuities.
The Freedoms legislation aimed to provide choice at retirement
Before 2015, the rules around pension incomes were largely restrictive. Most retirees would take their tax-free lump sum and use the remaining amount to buy an annuity to generate an income for life.
This could represent poor value for money if the retiree died relatively early, as the total income they received could be significantly less than the amount paid to the annuity provider. When Pension Freedoms legislation was introduced, it offered an alternative to how you could access your pension, which included:
- Taking all of your pot as a lump sum from the age of 55 (2022/23)
- Taking a series of lump sums
- Making flexible withdrawals as and when you need them.
If you take an income or series of lump sums, any amount remaining in your pension pot typically remains invested, allowing it to potentially grow in the future. As a result of these alternatives demand for annuities dropped significantly, although there was another reason too, which we will consider next.
The incomes offered by annuities tumbled
Not long after the legislation came into force, the income rates offered for annuities dropped significantly. This had nothing to do with the choice provided by flexi-access drawdown, but instead was a result of historically low gilt yields, which are used to calculate the level of income an annuity pays.
In 2019, Financial Reporter revealed that annuity rates had fallen to an all-time low, although things may now be looking up for those considering an annuity.
According to the Telegraph, income rates being offered by annuities have increased by more than 20% so far in 2022. This means that a 65-year-old with a £100,000 pension pot could receive an income of £5,940 a year – the highest amount since August 2014.
Furthermore, if you are above the age of 75, annuity income rose 18% from £6,697 to £7,905 between January and August 2022. While this is good news, there may be another reason why you may want to consider an annuity: peace of mind.
Let’s look at this now.
Flexi-access means your pension pot could run dry
As flexi-access drawdown could allow you to take as much as you want from your pension pot whenever you want, you may spend too much too quickly. As a result, your retirement fund may run out sooner than expected.
The chances of this may increase when the cost of living rises, as it has done in 2022. This is because you are likely to start withdrawing more money to maintain your existing lifestyle, which in turn could deplete your pension pot more quickly.
Furthermore, any money that you have not taken from your pension pot will typically remain invested. Because of this, your retirement fund could shrink in value if the stock market takes a downturn.
If at the same time you are withdrawing larger amounts of income to maintain your lifestyle, your pension could run out much more quickly than you thought. However, as an annuity is not linked to the performance of the stock market, and provides a guaranteed income for life, this is typically not an issue.
This provides peace of mind that you can maintain your standard of living whatever happens, or for however long you live for. This is particularly true if your annuity is linked to inflation, which allows the amount you receive to maintain its spending power.
A combination of both may be something to consider
Instead of deciding between flexi-access drawdown or an annuity, you might want to consider both. This means you could use an annuity to ensure your fixed expenses are met, and use flexi-access drawdown for discretionary expenses such as holidays, new car or to update your home.
Furthermore, as an annuity could provide your spouse with an income for the rest of their life if the worst happens to you, they too will have peace of mind that essential expenses are likely to be met.
Get in touch
Always remember that there are many factors that will affect the annuity rate you’re potentially offered, including your age, health, and lifestyle. For example, if you’re young and healthy, you’re likely to receive a lower annuity rate as the provider will expect to pay an income for longer.
Always remember that once you have set up an annuity, it cannot be changed.
If you would like to discuss your retirement plan, and whether an annuity should be included within it, please contact us on hello@ardentuk.com or call 01904 655 330. As we are an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can have peace of mind that you will receive excellent advice and the highest quality service.
Please note
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
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.
