Annuities – powerful pros and cons you need to know before deciding

01/03/2023

A report in Professional Adviser reveals that the number of comparisons for annuity quotes rose by a staggering 69% in the last quarter of 2022, when compared to Q1 2021. This is not surprising when you also learn that annuity rates increased by 44% since the start of the year, according to a report in MoneyWeek published in February 2023.

It explains that a £50,000 pension pot could secure an average annual annuity income of £3,113 in February 2023, up £683 from £2,430 in March 2022. These figures are based on a single life level without guarantee annuity.

As clients of Douglas White Financial Planning (DWFP), we will have considered annuities as part of your retirement strategy. While the increase in annuity rates might make them attractive, that doesn’t necessarily mean they’re right for you, your circumstances, and your retirement lifestyle.

Read on to discover when they may be right for you and when they might not be, and why you may want to merge them into your wider retirement income strategy. First, let’s look at the reasons you may want to consider an annuity.

An annuity might help protect your lifestyle

Following the 2015 Pension Freedoms legislation, retirees can access their pension once they have reached the age of 55 (increasing to 57 in 2028) in several different ways. This includes:

  • Taking all of your pension in one lump sum or several instalments
  • Taking an income from the pension pot
  • A mix of these.

If you access your pension pot in any of the above ways, it’s known as “flexi-access drawdown”. While this provides more flexibility it also carries risks, as you decide how much money you withdraw from your pension pot. As such, you could inadvertently take too much income and deplete your pension pot earlier than expected.

Meanwhile, because you give all or part of your pension pot to an annuity provider if you opt for one in return for a guaranteed income, you’re much less likely to inadvertently exhaust your retirement funds entirely. This provides peace of mind that you’ll always have an income.

That said, care should be taken, as the income provided by an annuity could still lose its spending power over time. Let’s look at how you can ensure your income does not drop in value in real terms.

An annuity could inflation-proof your income

As the cost of living rises over time, you need to ensure your income keeps pace with the increase. One way you could do this is to “inflation link” your annuity, which will ensure that your income rises in line with inflation every year.

This means the income you receive won’t drop in value in real terms.

At DWFP, we would encourage every client to inflation link an annuity, as it provides peace of mind that you’ll be able to maintain your standard of living for however long you live for – regardless of what happens to the stock market or the economy.

You may want to consider an “enhanced annuity”

If you have a health condition you might be able to receive a higher income in return for your pension pot, known as an “enhanced annuity”. You may be able to obtain this if you have diabetes, cancer, heart disease, or asthma.

This is not an extensive list, and we would be happy to confirm whether you could obtain an enhanced annuity if you have another condition.

While the above points may be very good reasons to consider an annuity, let’s now look at reasons why they may not be suitable for you.

Typically, your loved ones won’t be able to inherit your annuity

Most annuities stop paying out when you die. That said, there are additional policies such as “guaranteed term policies” that may extend your annuity to your next of kin, although this is normally bought in addition to your annuity.

One exception is if you have a joint-life annuity, which covers your spouse or other designated family member if you die first.

Annuities are usually inflexible

A key consideration with an annuity is that they cannot be reversed once you’ve agreed it, and you cannot change your mind. Furthermore, you cannot increase or decrease the amount of income you take, as you can if you access your pension pot directly using drawdown.

The charges associated with annuities may be high

As annuities are complicated, the costs involved in setting them up can be high, as can the fees to maintain them. As such, the charges could take a sizeable amount out of your retirement fund.

A mix of drawdown and annuities may be an option

In reality, when it comes to annuities it’s often not black and white. As clients of DWFP, you’ll know that we always take into consideration what will provide you with peace of mind, your retirement goals, and your circumstances.

This is why it may be worth considering a fusion of annuities and flexi-access drawdown as part of your overall retirement strategy. Using the annuity to make sure you’ve always got an (inflation-linked) income to help meet your essential expenses could provide you with financial peace of mind.

You can then use flexi-access drawdown for significant discretionary expenses such as holidays, a new car, or updating your kitchen or bathroom.

As the money you do not take from your pension pot in drawdown or to buy your annuity typically remains invested, it has the potential to grow, too. This may provide additional funds in the future and give your retirement fund a boost.

Get in touch

As you can see, even with the higher rates now being offered for annuities, it should not be assumed they are the best strategy for you. If we have not already discussed annuities with you, and you would like to find out whether they might dovetail into your retirement strategy, please contact us on info@douglaswhiteltd.com or call 0151 345 6828.

Please note

This blog is for general information only and does not constitute advice. It should not be seen as a substitute for financial advice as everyone’s situation will be different. 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.

The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.