Why Annuities Deserve a Second Look in Today’s Retirement Market
Buying Out the Risk of Running Out
We're continuing to have more conversations with retiring clients about annuities, and for good reason. The retirement income landscape has shifted significantly, making annuities worthy of serious consideration once again.
The Basics: Your Pension Options at Retirement
As a reminder, when you retire with a pension pot (technically, a defined contribution pension scheme), you can typically take up to 25% of the pot tax-free, up to a lump sum allowance of £268,275 (a lifetime limit spanning all your pensions in aggregate—some with protection will have a higher amount).
For the balance, you have choices:
You can take a 'flexible income' via drawdown—this could be a regular monthly amount, an ad hoc one-off payment, or some mix of the two.
Or you can use some of the pension monies to buy an annuity, which offers a guaranteed income for life.
A pension is a long-term investment and funds are not normally accessible until 55 (rising to 57 from April 2028). When investing via a pension, your capital is at risk. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.
Why Annuities Fell Out of Favour
Until recently, annuities were very much out of favour for two principal reasons:
Poor rates: Annuity rates are tied to interest rates, so when interest rates were near zero a few years ago, the economics simply didn't stack up.
Inheritance advantages of drawdown: With drawdown, the unused funds remain invested, which not only offers scope for additional growth but also means any unused pot can be passed down to your chosen beneficiaries on death—currently without any inheritance tax (IHT) to pay.
The Times They Are A-Changin’
However, circumstances have shifted considerably:
Rates have rebounded. The improvement in annuity rates over recent years has been substantial. Here's what current indicative rates now look like.
For example, a 66-year-old in good health could now secure a level annuity providing an annual income of £7,724 for every £100,000 invested. This equates to a rate of 7.72%. Whereas an RPI-linked annuity would start at £5,380 (5.38%), with the income increasing each year to help protect your purchasing power.
This table also highlights a crucial trade-off: the choice between a level and an inflation-linked annuity.
A level annuity offers a higher starting income. However, this income remains fixed for life, so its real value will be eroded by inflation over time.
An inflation-linked annuity, while starting with a lower payment (typically around 33% less), provides a rising income that helps protect against the corrosive effect of inflation. Over a retirement that could span 20 or 30 years, this protection can be invaluable. Consider that even a modest 3% annual inflation rate would halve the real value of your money in just 24 years.
The IHT rule change. With pensions set to form part of the estate from April 2027, the strategy of leaving a drawdown pot untouched faces a potential double death tax—IHT first (at 40%) and then income tax for beneficiaries if you die after age 75. This significantly erodes the inheritance advantage that made drawdown so attractive.
Annuity rates shown are indicative and subject to change. Actual rates depend on multiple factors, including health, lifestyle, and market conditions at the time of purchase. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
Our Preferred Strategy: Build an Income Floor
While every situation is unique, we believe a good starting point is to create a reliable income floor.
The idea is to use annuities to supplement your other secure, guaranteed income streams, such as your State Pension, a defined benefit pension, or rental income. The goal is for this combined income to comfortably cover all your essential living costs—plus a little extra for basic lifestyle expenses like hobbies and leisure. This strategy allows you to leave other investments and pension savings untouched to fund bigger, discretionary spending goals like holidays or gifts for the family.
This approach provide peace of mind, knowing that your core needs will always be covered, regardless of market conditions. It vastly reduces the risk of running out of money later in life.
Timing Your Annuity Purchase
Rates increase with age (as the income will inevitably be paid for a shorter period of time). However, there's also interest rate risk (you could lock in a lifetime income before an increase in interest rates) and mortality risk (you could buy an annuity and then pass away shortly after, which would represent poor value).
To mitigate these risks, we typically advocate a phased annuity purchase over time—for example, building up annuity income in four tranches, every two years between ages 62 and 68. This approach averages out interest rate fluctuations and (partially) reduces the impact of early mortality.
Understanding Your Options
This is an area where annuities are poorly understood. Many think they're inflexible, but there is considerable optionality available:
Income type:
Level payment: Higher initial income but stays the same throughout
Increasing payment: Lower initial income but increases either at a set percentage or with inflation (RPI)
Survivor protection:
You can provision for a reversionary benefit to pay continued income to a surviving spouse or partner should you predecease them (e.g., 50% or 100% of your income)
This will reduce the starting income, as it's effectively a joint life versus single life policy
Guarantee periods:
You can add a guaranteed period—typically 10 or 15 years—where the annuity is guaranteed to pay out in full during this period if you were to die early
This is like 'annuity insurance' and something we typically include with all our annuity purchases
A 15-year guarantee is typically low cost for someone in their 60s and will effectively ensure that the original purchase amount will be returned as income
A Worked Example
Consider the following example:
James and Juliet, both aged 62, are recently retired. They have combined pension savings of £1 million (£500,000 each), are in good health, are set to receive full State Pensions (£12,000 each per year from age 66), and estimate their spending needs at £5,000 per month, of which approximately £2,000 is classed as discretionary.
They decide to use half their pension savings (£250,000 each) to secure a guaranteed income via annuity purchase.
Their choices:
50/50 split of level and RPI-linked income
Two single life policies
10-year guarantee periods
The result:
Based on current indicative rates at age 62, they would each receive guaranteed annuity income of approximately £15,450 per year, comprising:
£9,050 level income (doesn't increase)
£6,400 RPI-linked income (increases with inflation each year)
Combined annual guaranteed income: £30,900
Once their State Pensions begin at age 66, total guaranteed income would rise to approximately. £54,850 a year—equivalent to around £4,080 a month after tax—most of which is inflation-linked.
They'll also have a further £500,000 combined in drawdown (£250,000 each), which can be accessed flexibly should they wish—for example, for additional discretionary spending, gifts to family, or unexpected costs.
Note, whilst we've illustrated this example assuming they fully annuitise their chosen amount at age 62, in reality, we would likely recommend phasing the annuity purchase over time.
The Key Benefits
By following this strategy, James and Juliet have:
Secured peace of mind by locking in guaranteed lifetime income—more than enough to cover essential costs and a little extra—regardless of market performance
Protected against inflation, with the majority of their guaranteed income (State Pensions and RPI-linked annuities) rising each year
Retained flexibility, with £500,000 remaining in drawdown to support discretionary spending, gifting, or legacy planning
Insured against early death, thanks to the 15-year guarantee periods on their annuities
Most importantly, they can enjoy retirement with confidence—knowing the essentials are covered and there’s room in the budget for the enjoyable extras.
Happy Thursday!
Kind regards,
George
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Important Disclaimer
This blog is for general information only and is intended for retail clients. It does not constitute financial or tax advice, nor is it an offer to buy or sell any specific investment. Since I don’t know your personal financial situation, you should not rely on this content as tailored advice. While we aim to provide accurate and up-to-date information, we cannot guarantee that all details remain correct over time. We are not responsible for any losses resulting from actions taken based on this blog’s content.
