Should you buy an annuity or wait?
With Brexit continuing to cause uncertainty, thousands of people approaching retirement were dealt a fresh blow this week with news annuity rates have hit a 25-year low.
The latest data from Moneyfacts shows the average annual annuity income is now 1.2 per cent lower than its previous all-time low recorded in September 2016, following the EU referendum.
This means a 65-year-old with a pension pot of £50,000 buying an annuity today would receive an average pay out of £2,237 a year compared to £2,557 had they bought the annuity on 1 January.
Annuity rates have been declining for months because of all-time low yields on gilts or government bonds, which are used to price annuities.
The perceived poor value of annuities was one of the drivers behind the pension freedoms introduced by former chancellor George Osborne in 2015.
The new rules gave people with defined contribution pensions more flexibility. They can keep their savings invested and take as much or as little as income from the age of 55.
Previously, this option – known as drawdown – was only typically chosen by people with larger pensions.
But annuities shouldn’t be dismissed altogether. They are the only product offering a guaranteed income for life.
And for many people, it’s not a case of drawdown or annuity.
“Some will use part of their pension pot to buy an annuity, providing enough guaranteed income to cover retirement essentials, leaving the rest invested in drawdown to be used flexibly as and when required,” says Steven Cameron, pensions director at Aegon.
With annuity rates at an all-time low, the price for a guaranteed income is at an all-time high. This leaves a conundrum for people approaching retirement: do they buy an annuity now or wait and see what happens to rates?
Can annuity rates fall further?
You may assume annuity rates can only go up and they could do if there was a Brexit inspired downgrade of UK government debt, according to Hargreaves Lansdown.
However, the firm said if the Bank of England cuts interest rates, you’d expect downward pressure on gilt yields and therefore on annuity rates as a result.
Nathan Long, senior analyst at Hargreaves Lansdown, says anyone coming up to retirement needs to choose their options carefully.
“It’s unlikely to be best to buy an annuity when you’re still working, but when you finally retire permanently a combination of secure income to cover the essentials and drawdown for the nice-to-haves is a solid approach,” he says.
For people who can’t bring themselves to buy an annuity at such low levels, they could defer purchasing one and take income from their pension investments instead.
Long says: “There are plenty of funds available that can pay high income levels, but ensuring you have a spread of funds to provide income in retirement is sensible.”
He then suggests buying several smaller annuities using tranches of your pension as you get older.
“You can benefit as annuities generally pay more as you get older and any health conditions that develop can be factored in which can also boost the payouts.”
Cameron concludes: “With so much choice, coupled with no-one knowing for sure how long they will live in retirement, we always recommend people seek advice.
“An adviser will be able to help you identify your current needs, your appetite for taking investment risk and the pros and cons of deferring annuity purchase with some or all of your funds.”