5 questions to ask yourself before buying an annuity

High interest rates have helped boost the amount you can get from an annuity over the past few years but, with rates now on a downward trend, you might be wondering how this affects your retirement plans. 

An annuity lets you exchange pension savings for a guaranteed lifelong income, but the amount you get depends on the provider's rate and the type of annuity you choose. 

Here, Which? explains what’s happening to annuity rates and five key questions to ask yourself before purchasing one.

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What's happening to annuity rates?

Annuity rates are based on several factors, including the size of your pension, your age and the external economic environment.

Annuity providers back their annuities by buying long-term (usually 15-year) UK government bonds, known as gilts. As long-term gilt yields increase or decrease, so too do annuity rates. 

According to experts, it’s likely that annuity rates will start to fall back in the coming months but are still offering good value for money. 

Helen Morrissey, retirement expert at Hargreaves Lansdown, said: ‘After years on the retirement income sidelines, the higher interest rate environment ushered in a golden era for annuities as income soared.’

'They’ve since fallen back from their highs, but with a 65-year-old with a £100,000 pension currently able to get up to £7,102 per year from a single life level annuity, they are still offering good value.’ 

• Find out more: best annuity rates

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5 questions to ask yourself before buying an annuity

If you're thinking about purchasing an annuity, these are the five things you should ask yourself beforehand. 

1.  How much income do you need in retirement?

It can be hard to tell exactly how much you will need to live on in retirement.

The Pension and Lifetime Savings Association (PLSA) has developed three ‘retirement living standards’ to help address this problem. These reflect the amounts you’d need for a minimum, moderate and comfortable standard of living in retirement.

It estimates a single person will need to generate an income of £14,400 a year for a minimum standard of living (including a week-long UK holiday and £50 a week to spend on groceries), while a two-person household would need £22,400 a year.

But for a comfortable retirement (including a 4-star holiday in the Med with spending money, three long weekend breaks in the UK, and £70 per week to spend on groceries) a single-person household would need an annual income of £43,100, while a two-person household would need £59,000 a year.

The state pension will make up some of your retirement income, but not all, so what you decide to do with your private pensions is important in making up the rest.

• Find out more: how much do you need to retire?

2. Is an annuity the best way to cash in your pension?

Buying an annuity used to be the only option for most people who had a defined contribution pension, but now you can opt to use income drawdown or take a lump sum.

Income drawdown allows you to keep your pension fund invested in the stock market and draw out income when you wish.  This might suit you if you want more flexibility to take money out as and when you want and if you want to take out different amounts each year.

You may also be able to take your entire pension savings out as cash for you to spend how you wish. This might be a better option for you if you have serious health conditions and a guaranteed income for life might not be worthwhile.

• Find out more: how annuities work 

3. What type of annuity do you need?

There are many different types of annuities, so you should think about which would suit your circumstances best.

For example, a level annuity will pay you the same income each year for the rest of your life, while an escalating annuity will rise each year at a fixed rate to help you keep up with inflation.

If you have a partner, a joint life annuity - which may provide a slightly lower income - might be more suitable. This type of annuity will ensure your spouse continues to receive payments if you die first.

• Find out more: options for cashing in your pension pot

4. Can you get a better rate?

When you get a quote for an annuity, you'll be given an annuity rate as a percentage. This will determine how much income you get each year. 

For example, if you have £100,000 in your pension pot and are offered an annuity rate of 5%, you'll get an annual income of around £5,000 a year. 

Just don't automatically accept the annuity rate offered by your pension provider without checking what's on offer across the rest of the market.

You can use tools such as the MoneyHelper annuity comparison tool or use annuity brokers to find the best deals currently available in the market, and tailored to your circumstances. There may also be annuity providers offering higher rates only via a financial adviser.

• Find out more: best annuity rates

5. Have you been honest about your health?

Standard annuities are based on average life expectancy - currently 84 for men and 86 for women.

But not everyone lives this long, so some providers offer enhanced annuities to people in poor health or with lifestyle conditions that mean they might die earlier.

Hargreaves Lansdown says including details such as whether you have had a stroke could push your income over £8,400 per year, while someone who smokes 10 cigarettes a day could receive more than £7,600.

• Find out more: where to get retirement pension advice 

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