Annuity rates today are rising in the UK and a big reason for this is the rise in interest rates.  

So if you have considered using your pension to secure an annuity in the past but put it off because you thought annuity rates were too low, is now the time to go for it? 

In order to make a decision you need to know how annuity rates today compare to that of the past and what alternative options you have available.

Are annuity rates today high?

An annuity is a way of securing an income from your pension for the rest of your life. In simple terms, you take your pension pot to an insurance company, sell it to them and in return they will pay you a regular income. Your pension pot is gone but you will receive an income for as long as you live. 

Annuity providers take your money and invest it in fairly safe bonds which give them a set rate of interest which they can then pass on to you for your income.  

The rate of annuity you will be offered will depend on things like your age, health, where you live and most importantly the government gilt yields at the time.  

Annuity rates today are most closely linked with the 15yr UK gilt yield which at the start of May 2022 was around 2.2%. This is much higher than a low point back in mid 2020 when rates were around 0.30%.  

The reason for the increase? The Bank of England are increasing interest rates mainly in an effort to combat high inflation. 

But even these higher annuity rates today are still some way off from back in 2007 when 15yr gilt rates were over 5%. 

So what’s on offer based on annuity rates today? 

Well the final offer from the annuity company will very much depend on your own personal circumstances and which type of annuity you chose but as an example: 

A £1 million pension pot could provide a £250,000 tax free lump sum and an annuity income of £26,590 gross increasing by 3% per year. This is based on a male applicant age 65, joint life annuity (one half to survivor), 10 year guarantee.  

(Based on annuity quote dated 23/05/2022.) 

Why would someone want to give up a £1 million pension pot? After all, on second death there is nothing left for the children.  

Well it all depends on your nature. Are you someone that craves certainty and has a very low attitude to risk? 

Think of an annuity as a secure employed job whilst your working, perhaps in the public sector where there is little chance of your employer going bust. 

What’s the alternative?  

If you were slightly more risky you might decide to re-educate yourself and change jobs. At the extreme end of the risk scale you might decide to go self-employed where there would be no certainty on how much you could earn. The rewards could be much greater and you could leave a business behind as a legacy or it could all go horribly wrong and the business fails.  

The alternative to an annuity is leaving your money inside a pension pot and using drawdown instead.


Possible income by keeping your pension in drawdown vs annuity rates today

Pension drawdown means you can take as much or as little out of your pension pot as you wish subject to minimum pension age.  

This offers far more flexibility but comes with risk.  

Your pension will remain invested and if you choose the wrong investments and take too much out you might find your pension pot runs out.  

On the other hand, if you are prudent you could leave behind a legacy in the form of a pension pot for your spouse and children. 

So based on annuity rates today, what’s going to deliver you a better outcome, an annuity or drawdown? 

Well in our example above a £1 million pension pot secures an annuity income of £26,590 gross per year. If the £250,000 tax free lump sum was left in cash and used every year to top up the income then based on the last 100 years of historical financial market data, this could actually ensure spending of £25,200 per year after taxes in the worst case scenario.  

Alternatively, keeping the pension pot invested at a fairly medium risk profile (60% equities / 40% bonds) and drawing down from it could ensure spending of £31,600 per year in the worst case scenario.  

So using history to see how someone would have fared using an annuity based on annuity rates today vs pension drawdown, you would have been better off keeping your pension invested in drawdown.  

If you were to match the spending produced from the annuity by using drawdown, e.g. only drawing enough to match the £25,200 annuity spending then this would actually leave behind a pension pot of £452,000 (in real terms) based on living to age 100 and using the worst case scenario.  

A third way could be to look at a half and half approach. Use half of your pension pot to purchase an annuity and leave half invested using drawdown. 

In this case a £500,000 pension pot could provide a tax free lump of £125,000 and an annuity of £13,285 gross per year based on the same type of annuity as above. 

Interestingly, together with the remaining £500,000 pension pot that you keep invested and use drawdown, based on the worst case scenario you could sustain spending of £32,100 per year.  

Using this option, if you were to match the £25,200 spending in the other two scenarios this would leave a lower overall pot on death of £370,000 at age 100. 

So to summarise using a £1 million pension pot and annuity rates today: 

Option  Maximum spending per year based on historic worst case scenario 
100% Annuity taking £250,000 tax free cash lump sum  £25,200 
100% Drawdown  £31,600 
50% Annuity taking £125,000 tax free cash lump sum and 50% Drawdown  £32,100 

What’s left behind based on spending £25,200 per year:

Option  Legacy based on living to age 100 and using historic worst case scenario 
100% Annuity taking £250,000 tax free cash lump sum  £0 
100% Drawdown  £452,000 
50% Annuity taking £125,000 tax free cash lump sum and 50% Drawdown  £370,000 

So on the face of it, the 50/50 option seems to provide the most income but less left over for your loved ones on death.  

There’s a good chance that interest rates will continue to rise in the short term but of course that’s not guaranteed.  

Annuity rates today are better than they were a few years ago but not as good as they were the longer you go back.  

Choosing an annuity is a one-off irreversible decision so it’s essential you take your time to look at this properly. 

It all depends on how you feel about certainty vs flexibility.  

If you were to go down the pension drawdown route you need to be very mindful of getting the right investment strategy to see you through and also understand the tax implications. There’s the potential that you could pay very little in Income Tax if you make your withdrawals in the right way. Professional advice is essential. 

If you would like your retirement plans stress tested and to ensure your pension doesn’t end up paying lots of tax then please schedule a no obligation free 15-minute call 


Risk warning:

Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.