Should retiring employees be considering annuities right now?

Jonathan Watts-Lay, Director, WEALTH at work answers some key questions on annuities in light of the recent uplift in the rates available.

Q: Is it time for annuities to make a comeback as annuity rates are the highest they have been for 8 years?

A: Annuities certainly have fallen out of favour in recent years, mainly due to the rise of income drawdown which is appealing to those wanting more flexible access to their retirement income, and as a result of low annuity rates.

However, with annuity rates on the rise, those who are looking for more security may be tempted to explore the option of an annuity. This could be particularly true for those concerned about the impact of the cost of living crisis, as an annuity provides a guaranteed income, and can be indexed linked.

Q: Is it time to revamp employee communications to consider annuities again?

A: It’s important that employees understand all of their income options at retirement and which might be the best for them, in order to be able to make an informed choice; whether that be an annuity or other options like income drawdown, cash withdrawal or a combination of options. As individual circumstances change, it may not even be as straightforward as picking only one option and a pick and mix approach may be best. For example, for those who want the security of an annuity whilst still wanting some flexibility, they may want to consider using some of their pension savings to purchase an annuity that meets their core needs, while keeping the remainder invested to do with what they wish.

Financial education and guidance could be the best way to help employees understand the advantages and disadvantages of each option, some may even need regulated financial advice with help deciding what is right for them.

Q: What are the key pros and cons of annuities for employers and trustees to explain to their members?

A: A lifetime annuity is an insurance policy which pays a guaranteed pension income for life. The rate of income that is paid is agreed when the annuity is purchased, and this can either increase in line with inflation, or remain at the same level for life.

However, employees will need to understand that the amount of income received will be based on individual circumstances, including the employee’s age, health, lifestyle choices and where they live.  Other factors, such as the size of the pension pot used to buy the annuity, the options selected and the annuity rates available when the annuity is purchased will also influence the income payable.

They will also need to know that there are a number of variations on the type of annuity offered. This can include an enhanced annuity which pays a higher income if aspects of an individual’s lifestyle may shorten life expectancy such as smoking, drinking alcohol or their medical history; or an impaired life annuity which pays a higher income than a standard annuity for those who have significantly lower life expectancy due to an existing medical condition.

A lifetime annuity is the only way for an employee with a defined contribution pension pot to guarantee an income for their entire retirement.  It also offers the option to provide a guaranteed income for a surviving partner after the employee’s death, together with the option to choose an income that increases over time with inflation.

This level of security comes with some important considerations that should be made.   Once purchased, an annuity cannot generally be changed.  This means that the options chosen at the outset remain in place for life, and there is normally no option for an employee to change their mind and receive their pension pot back in the future. Also, in the event of death, there is no return of any pension fund unless a protection option has been selected.

If employees are thinking of selecting an annuity, it’s important that they shop around as rates and benefits can vary widely.