Pension Annuities

Is now the right time to buy one?

The massed ranks of the UK’s ‘the soon to be retired’, all face the same question, namely do I have enough savings to last me during my retirement? It’s the same question, whether your pension pot is a self-invested personal pension (SIPP) or a workplace defined contribution (DC) scheme.

You’ve worked hard to build up a decent pot of savings for your retirement, and as this potentially life changing event is now rapidly approaching, but what do you do to secure your financial future?

No doubt your first thought is to try and work out how much income you’ll need for a comfortable lifestyle in your later years and just how much to take out of your pot as a cash reserve for those little luxuries in life, such as more holidays. Withdraw too much, and you risk depleting your nest egg and surviving on little more than the state pension before you shuffle off this mortal coil. Withdraw too little, and you may have to forego those little luxuries that you hoped to enjoy in retirement.

The other main issues that many new retirees grapple with is how much of their assets, including any remaining pension pot, to pass on to your loved ones and secondly, could it be hit with inheritance tax (IHT) in the future. IHT is an issue I have covered recently and will no doubt return to, dependent upon what Rachel Reeves announces in her upcoming Budget on November 26th.

At this moment in time, annuities are most definitely flavour of the month, with retirees using a much greater portion of their savings to buy an annuity, primarily because of historically high annuity rates. But first, do you know what an annuity actually is?

What is an annuity?

In essence, an annuity is a contract between an insurance company and an individual purchaser. The purchaser either makes regular payments, usually over many years, into a savings account or hands over a lump of cash. These accumulated monies constitute your pension pot, which is then converted into an annuity contract that pays out a fixed or variable income stream to the purchaser.

People who invest in annuities are looking to receive a regular income in retirement with the insurance company paying them regular payments for a specified period of time or for the remainder of their life. Annuities are used almost exclusively for retirement income purposes and are usually bought by individuals to avoid the risk of outliving their savings.

Annuity take-ups on the rise

Over the last five years, the average pot size used to buy an annuity has nearly tripled. At the same time, there has been a significant improvement in annuity rates, which remain close to record highs. Recent data from the Chartered Insurance Institute shows that as of 30th June 2025, the average annuity purchase size was £164,240, a huge increase from the average of £55,870 only five years earlier in June 2020.

During this time, annuity rates have grown sharply thanks to rising interest rates and high gilt yields and the recent decisions from the Bank of England to cut interest rates have had minimal effect on the gilt rates currently on offer. (gilts are government bonds issued to raise capital and pay fixed interest, the interest paid is combined with any capital gain or loss from buying the gilt and is known as the gilt yield).

Currently, someone aged 66 with a £164,240 pension pot can now get up to £12,898 a year from a single-life level annuity with a five-year guarantee (ie it will pay out for five years, even if you die before then). By comparison in September 2020, the equivalent figure was £5,000 lower at a miserly £7,843.

Figures from the Association of British Insurers (ABI) show annuity sales reached a 10-year high in 2024, an increase of 34% on the previous year. The ABI’s research also shows that nearly half of all individuals say that having a guaranteed income is their main priority in retirement.

How annuities work in practice

Deciding on which type of annuity to purchase, involves using some or all of your pension savings for a guaranteed income for the rest of your life. It goes without saying that exactly how much you’ll receive, depends on the type of annuity and the rate offered by your chosen provider.

When providers decide on the annuity rate they’ll offer, they consider a number of factors, which always include:

• The broad economic situation expected in the medium term (In investment &finance terms, a medium-term investment horizon is usually between 5 and 10 years)
• Your age when taking the annuity
• Where you live (For example, an individual living on the south coast such as in Bournemouth, would get a better rate than if the same individual lived in an industrial working town such as Doncaster)
• Your health. You’ll get a higher income if you have a medical condition that could shorten your life expectancy
• Wider family medical history, especially a history of certain medical condition, such as heart attacks and cancer in your family. If there is, it usually results in a higher annuity rate

Other issues to consider

When looking for an annuity, astonishingly over 50% of people take the first offer from the insurance company they’ve made their pension contributions to, without shopping around. This really is a classic example of ‘shooting yourself in the foot’, as even the ABI admit that it is highly unlikely that the first offer will be the best available.

Taking the average amount used to purchase an annuity this year (£164,240), the best annual payout you can get for a single-life level annuity as a healthy 66-year-old (as opposed to the poorest), will give you £42,560 extra over the course of a 20-year retirement, a huge difference (just think of all those lovely cruises you could been on!).

Prudent planning before buying an annuity is vitally important because once purchased, an annuity cannot be changed, even if your circumstances have. If you’re married you may decide to opt for a joint, rather than a single-life annuity, so your partner still has an income if you die first. This will normally pay out to your surviving spouse 50% of the amount that you were receiving, but at the cost of paying you less.

It’s also worth remembering that inflation is likely to significantly reduce the value of your pension over time. You might therefore wish to consider an inflation-linked annuity, where payments rise over time, but start much lower than for ‘level’ annuities, which pay a fixed amount.

Unless ‘Dear Rachel’ moves the goalposts, yet again, you’re also entitled to withdraw up to 25% of your pension pot tax-free, but this will have the knock-on effect of reducing your regular payments by the same percentage.

Finally, for those of you who intend to continue working after the official retirement date but would like to withdraw periodic lump sums from your pension pot, you should consider the ‘4% Rule’. This was coined by renown financial planner Bill Bengen in the late 1990’s and demonstrates that you can withdraw up to 4% of your pension pot each year, without affecting the size of the original pension pot investment which would still grow, albeit more slowly.

Accountant’s view

I hope that today’s Blog has given you food for thought, especially those of you approaching retirement age in the not-too-distant future, I would urge you to do your own extensive research before committing to a decision that you may not be able to revoke. However, if you still need help, I suggest that you contact an independent financial adviser, their modest fees could well save you a small fortune in the long run.