Is buying an annuity the key to a happy retirement?

Retirees with an annuity enjoy greater satisfaction with life and fewer affordability struggles, according to research published by Legal & General.

Although sales of annuities rose last year - to more than 80,000 - they accounted for just 9% of pension pots accessed for the first time in 2023-24. 

Here we look at the pros and cons of arranging an annuity and the alternatives for turning your pension savings into a retirement income. 

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Annuity holders feel happier and more confident

Buying an annuity involves swapping some or all of your pension savings for a guaranteed income for the rest of your life. 

Retirees who arranged an annuity have reported greater satisfaction with their current lives, relationships, free time and social activities, according to Legal & General. They are also 51% more likely to claim lower levels of stress than those who don't have an annuity.

Annuity holders are also 40% more likely to consistently afford their credit card payments or loans, and more likely to report a higher level of financial confidence compared to those without an annuity (24% vs 21%).

The findings come from a study by Legal & General and the Happiness Research Institute, an independent Danish think tank focusing on wellbeing, happiness and quality of life.

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Higher annuity rates boost sales

Only 9% of pension pots accessed for the first time in 2023-24 were used to purchase an annuity, according to the latest data from the Financial Conduct Authority (FCA). 

New purchases increased by 39% to reach 82,061 in 2023-24, their highest level for nearly 10 years. This was driven by an increase in the rates offered by annuity providers.

Providers consider economic factors and your personal circumstances – such as your age, location, and health – when pricing an annuity.

It's important to shop around to make sure you're getting the best rate. Once you've arranged an annuity, you can’t alter it or switch to another provider.

• Find out more: What are annuities?

Annuities vs pension drawdown

There is no investment risk involved with an annuity and no ongoing charges to pay. 

However, the fact that your money is no longer invested also means it will no longer have the opportunity to grow.

With pension drawdown, you keep your savings invested and draw out income when you wish.  

This flexibility to take money out as and when you want has made it the most popular retirement income option.

But there are risks to consider. It's up to you to manage your investments and withdrawals carefully to ensure your pot lasts for the rest of your life. The value of your pot could take a hit if your investments underperform, or if you withdraw too much too soon. 

In whichever way you choose to access your pension, you can take the first 25% as a tax-free lump sum. The rest will be added to your income for the year and taxed accordingly.

• Find out more: Best pension drawdown providers 2024

Mix and match your retirement income

You can take a retirement income using both annuities and pension drawdown. It’s not a binary choice. 

For example, you might decide to start off with a drawdown plan and then buy an annuity later in retirement. 

You'll generally find that the older you are when you arrange an annuity, the higher the annuity rate you'll get, reflecting the fact that the annuity provider won't have to pay out for as long. 

Based on current rates, a healthy 65-year-old with a £100,000 pot can earn around £7,500 a year from a single-life, level annuity. For a 75-year-old this rises to more than £9,800 a year.

Lorna Shah, managing director of Legal & General Retail Retirement, said: ’While the benefits of an annuity can often be overlooked when it comes to retirement planning, it’s important to note they don’t have to be the only solution as they can be part of a blended approach. 

‘Combining the guaranteed income of an annuity with other sources, such as income from investments or drawdown, can provide even more flexibility, ensuring that essential expenses are covered, while offering the freedom to grow other assets.'

• Find more: What can I do with my pension pot?

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