As the economy is rocked by mayhem in the bond markets there is very little upside – least of all for Rachel Reeves who finds herself with a lot of explaining to do.
The cost of Government debt is soaring, mortgage costs could start to inch up – and holidaymakers may be in for a nasty surprise as the pound falls against the euro and US dollar.
But there is one group of people enjoying an unlikely silver lining. In fact, the worse the bond mayhem becomes the better off they might find themselves.
They are workers who are thinking about – or have very recently – retired.
That’s because the retirement income they can secure in return for their pension nest egg is higher this week than it has been since 2008.
In fact, someone buying a retirement income today could secure a deal that is a massive 70 per cent higher than if they had bought in 2020, when deals hit a record low.
Annuities are a financial product that allow you to buy a guaranteed income – either for life or a set number of years. Retirees typically buy them with the pension funds they have built up over their working lives.
Pension providers and insurance firms sell annuities using a simple business model. They essentially buy your pension pot from you and use it to buy government debt that pays out an annual interest rate, known as a yield.
As yields on government debt have risen in recent days, so have annuity rates. Pictured: A chart showing the 10-year gilts rate
Financial adviser William Burrows believes now is the best time to arrange an annuity since the 2008 credit crunch
They use this yield to pay you a guaranteed income for life. The higher the yield on government debt, the better the income they can afford to pay out to their annuity customers. As yields on government debt have risen in recent days, so have annuity rates.
The yield on government debt that pays out for 15 years – so called 15-year gilts – surged above 5 per cent this week for the first time since 2008, which has in turn pushed up the annuity rates available.
The level of income that you manage to secure is life-changing. Unlike many other financial products, once you have bought an annuity you can’t ditch it and buy another if a better one comes along. The income that you lock into is the income you receive for life. Buying a good one can leave you with a more comfortable retirement for the rest of your life – and even for your spouse if they outlive you.
If you had bought an annuity in 2020 when rates had reached rock bottom, you would have received an income of around £3,800 a year.
That assumes you were 65 years old, and paid £100,000 for an annuity that does not rise with inflation and continues to pay out two-thirds of the income to your spouse – who is five years younger – when you die.
But if you bought the same annuity today, you would receive £6,465 a year – an extra £2,665 a year or potentially tens of thousands more over the course of your retirement.
Such is the magnitude of the bond market turmoil this year that the income you would receive has risen by more than 1 per cent since January 1 alone.
Had you locked into an annuity ten days ago, you would have received £6,412, using the same assumptions as above. That is the difference of £53 a year for the rest of your life. Had you bought one a year ago, on January 1 2024, you would have received £5,986 – £479 a year less than today.
It’s no wonder that annuities expert William Burrows, who runs The Annuity Project, is a financial adviser at Eadon & Co and provided the figures above, believes now is the best time to arrange an annuity since the 2008 credit crunch.
‘The outlook for 2025 is very uncertain and now may be a good time to lock into the high annuity rates,’ he says.
Should you take advantage of high rates and lock in a guaranteed income?
For years, annuities were the status quo as retirees had no choice but to buy one with their pension pots.
But that changed in 2015 when former chancellor George Osborne introduced so-called ‘pension freedoms’, which allowed retirees to do as they choose with their savings.
Since then, pensioners can still buy annuities. But now they can also choose to keep their pension funds invested and use it almost as a cash machine, taking money only as and when they need it. One of the biggest advantages of this strategy, known as drawdown, is that your untouched funds should continue to grow over the long term because they remain invested.
When this option was introduced, the popularity of annuities plummeted. Rates were low for several years and retirees liked the idea of managing their own pension pot how they liked. They were happy to give up the security that an annuity offers in favour of the freedom that drawdown affords.
Drawdown has another huge advantage over annuities. Any pension funds that you have not spent when you die can be inherited by your loved ones. Not only this, but they could be passed on free of inheritance tax. If you die before the age of 75, they pay no inheritance tax on your pensions at all. Die after 75 and they pay income tax on it, but not inheritance tax.
By comparison, annuities die with you – or if you take out one for you and your spouse they die when the second partner passes away.
However, the tide is starting to turn and annuities are becoming more popular again.
Perhaps the biggest reason is that they are now so much more generous.
But a change to inheritance tax rules announced in the Chancellor’s Budget last October is likely to make them even more popular.
From April 2027, pensions will no longer be exempt from inheritance tax. The precise rules are yet to be ironed out, but in essence any money remaining in your pensions when you pass away will count as part of your estate when its inheritance tax liability is calculated.
In one fell swoop, drawdown will lose one of the key advantages it holds over annuities.
What to consider if you are thinking about an annuity
Although annuity rates are looking very favourable, you shouldn’t rush into any decisions
Taking out an annuity is a huge decision – and one that you can only make once.
One of the biggest mistakes people make is simply buying the one offered by their pension provider rather than shopping around.
Helen Morrissey, head of retirement analysis at investment platform Hargreaves Lansdown, warns: ‘The higher incomes on offer will add an extra incentive for people on the lookout for a guaranteed income to take the plunge now but it is important that you use a search engine to gather quotes from across the market before choosing an annuity.
‘Different providers offer different rates and if you just accept the first quote on offer then you risk being thousands of pounds worse off over the course of your retirement.’
The second pitfall is not admitting to all of your bad habits. When buying financial products such as insurance, poor health tends to work against you. But when buying an annuity, the poorer your health and lifestyle the better the annuity you are likely to secure.
Annuity providers work out roughly how long they think you are going to live to estimate the duration they are likely to have to pay you an income. If you are in poor health, smoke or drink excessively, that is likely to curb your life expectancy and so your annuity provider should be able to pay you a more generous annual income because it won’t be paying it for as long as if you were in perfect health. Make sure you disclose everything. If you are in poor health, you should be eligible for what is called an enhanced annuity – in other words, a higher income one.
As an example, a 65-year-old in good health taking out an annuity with £100,000 would receive £7,287, assuming the income does not rise with inflation. But someone of the same age who has smoked ten cigarettes a day for the last 20 years and drinks the equivalent of just over seven glasses of wine a week would receive £8,055 a year – an extra £768.
These figures – and the following ones – are all taken from Hargreaves Lansdown’s best annuity rate tables. They are free to view even for non-customers, are updated every week and are a good option if you’re looking for a snapshot of the type of deals that are available, if you are thinking about going on to shop around for an annuity. Go to: www.hl.co.uk/retirement/annuities/best-buy-rates
A third mistake people make is not thinking about their spouse. You can either use your pension funds to buy a single annuity – that pays out to you until you die – or a joint one that pays out to you and your spouse until the second person dies.
The latter is inevitably more expensive, but means you don’t leave your spouse without an income should you pass away. For example, a single 65-year-old would receive £7,287 a year if they annuitised £100,000, or £6,692 if the income continued to pay out to a spouse when they died.
Another consideration is inflation. Some annuities pay out the same figures in pounds and pence every year until you die.
Others have inflation protection built in so the amount you receive in pounds and pence increases every year so that you receive the same income in real terms. A third option is an element of inflation protection.
So, for example, the annuity could increase by 3 per cent every year – which should be sufficient protection if inflation is cruising around the Bank of England’s target of 2 per cent but will not be enough if inflation really starts to escalate as it did in the wake of the pandemic and the start of Russia’s war in Ukraine.
For example, a healthy 65-year-old taking out a single annuity with no inflation today would receive £7,287 a year. If they opted for an annuity that increased by the retail prices index measure of inflation every year, they would receive just £4,786 in the first year. In this example, they also have a five-year guarantee, which means that even if they die within the first five years of taking out an annuity, their family will still continue to receive the income for the rest of this period.
So income or drawdown?
This is the million-dollar question and one that really comes down to both your own financial circumstances and your feelings about security versus freedom when it comes to your money.
Pension Wise is a good source of information to explore the issue further. It’s free, government-backed and impartial. Go to the Money Helper website.
Over-50s are also eligible for a free appointment with a Pension Wise expert. Appointments on the phone last around 60 minutes.
If you are at the point at which you are considering your options for retirement, you may also find paid-for financial advice useful.
It’s also worth remembering that the choice is not either/or. You can, for example, take out an annuity to give yourself a base line retirement income using some of your savings and leave the rest in drawdown.
You can also choose an annuity for a set period of time. This is often considered by those who stop work before state retirement age as it offers them an income to tide them over before they start receiving their state pension.
Annuities can be bought from the point at which you can access your pension savings (at age 55, but rising to 57 in 2028), but the longer you wait the higher income you’ll receive.
As Helen Morrissey at Hargreaves Lansdown explains, although annuity rates are looking very favourable, you shouldn’t rush into any decisions. ‘Don’t feel like you are forced to annuitise your whole pension now if you are unsure – you need to do what’s best for your circumstances. If you need more flexibility you can adopt a blended approach where you annuitise in stages throughout retirement.
‘You can keep the rest of your pension invested in the market where it has the potential to grow and you can annuitise in further slices as you age. This should also mean you get higher annuity rates as you age.’
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