Annuities: Are They a Good or Bad Idea?

According to a report by the International Longevity Centre UK (ILC-UK), when the average person retires they reduce their spending on non-essential items and their consumption decreases overall.

To reduce this stress, many pensioners turn to annuity products, which can offer a stable and reliable income throughout retirement.

However, as with any financial product, it’s important to do your research and only take advice from professional advisors.

To help you understand more about the pros and cons of annuities for retirement income, we’ve created this guide.

We can arrange a free pension review for you today

70% of customers who have a pension review find a better deal

We can arrange a free pension review for you today

70% of customers who have a pension review find a better deal

Are annuities a good idea?

It’s not uncommon for retirees to feel uneasy about spending their retirement funds.

A lifetime of spending wisely and saving strategically can lead to many people worrying that their funds will run out too soon and so rather than enjoying their retirement, they continue to live fairly frugally and worry about their future income.

An annuity could offer a solution to this problem and for many, the peace of mind that comes with knowing that they have a guaranteed income for life can be a huge help.

Whether an annuity is the right choice for you will depend on your retirement needs and personal circumstances. Read on for more information or make an enquiry to discuss this with an independent expert.

What if I have a high life expectancy?

Retirees with no health issues and a predicted high life expectancy can receive less in their annuity payments throughout the course of their life. This is because the longer a person lives, the more the insurer may have to pay out over time.

Therefore, to reduce their costs, annuity providers use the information about your age, health and lifestyle to calculate how long you will live and how much they could potentially have to payout.

If you’re thinking about buying an annuity, it’s important that, before signing any contract, you ask the insurer how much they can pay you as a guaranteed income.

It may be the case that the minimum income offered by the annuity provider is too low, so a solution would be to deposit a higher chunk of money in exchange for a higher income.

This could mean that you use a larger portion of your overall retirement pot. However, the good news is that if you do purchase annuities with your retirement pot, the first 25% of your retirement drawdown is tax-free.

What if I want to leave money for my family?

It was reported by the ILC-UK that some retirees are reducing their consumption in a bid to leave their family some inheritance.

Depending on your level of income and the size of your pension pot, it could be possible to withdraw a fraction of your overall pension pot to buy an annuity and then keep the rest to either have as additional income, savings or to leave as an inheritance.

In fact, it may be possible for you to take 25% of your pension pot tax-free if you decided to use the money to purchase an annuity.

What if I want to leave an inheritance?

Another option for those looking to leave an inheritance to their family is to purchase annuities with a death benefit clause.

This would mean that if you were to die, your named beneficiary would inherit the annuities in the account. For many couples and families, this can provide peace of mind.

It’s important to note that in some cases, inheriting a lump sum can lead to some beneficiaries having to pay high rates of tax. This is because the inheritance would be classed as income and would, therefore, be taxable.

To avoid this, it could be helpful to seek the advice of a pensions expert. They can calculate the tax implications ahead of you buying annuities and recommend other avenues.

What are the advantages of investment annuities?

A big advantage of an investment-linked annuity is that the money used to purchase annuities is tax-free.

This means that when you withdraw 25% of your pension to purchase an annuity, you could be saving money or even making money on your income, all without the cost of tax.

These types of products are often referred to as with-profit annuities because they are investment-linked.

Another benefit of investment-linked annuities is that some have no annual contribution limit. This means that some retirees are able to make investments and accumulate tax-free money.

This can be especially beneficial for those looking to build on their overall pot, as an increase in pension could result in an increase of inheritance for beneficiaries.

What are the disadvantages?

A problem with some retirement annuities is that if the payout is linked to an investment strategy there is a potential to lose money.

Although some contracts may state that a minimum guaranteed income will be paid, your overall pot and therefore your retirement income could significantly be reduced if the investment strategy of the insurance company were to fail.

Furthermore, there can also be a limit on how many times you can withdraw your money from the point of signing to the contract end date.

If you needed to make a further withdrawal which would take you over the maximum withdrawal amounts, you could be penalised and be subject to a withdrawal fee.

These could be expensive, so if you’re deciding whether annuities are worth it or not, always have a professional thoroughly read your contract and make you aware of the annuity risks before you sign.

Annuity risks: fixed and variable annuities

Another factor to consider when comparing the advantages and disadvantages of annuities is whether the income you receive will be your only source of capital or savings. For those depending solely on income from their annuity, this could be risky.

Problems with fixed annuities

While it’s true that some annuity products such as a lifetime annuity payout a guaranteed income until death, the income is fixed and will not increase with inflation.

For some policyholders, this could be a risk. Although the income from a fixed-rate annuity is dependable, it may not be enough to live comfortably on should inflation increase as this could cause living costs to dramatically increase.

Problems with variable annuities

That being said, annuity products that pay out a variable rate can also come with risks. If the annuity providers offer a variable rate that is linked to either an investment strategy or the rate of inflation, the level of income paid out could vary and even drop to a level that could mean that your income could significantly decrease.

What is the best type of annuity for me?

There are plenty of annuity providers  and many have advantages and disadvantages to the terms of their annuity agreements.

There are also a range of annuity products which each have pros and cons depending on what it is you want to achieve from your retirement fund.

These include:

  • Lifetime annuities: These provide a fixed income for the rest of your life
  • Enhanced annuities: You may have to meet certain eligibility requirements for this type of annuity as these can pay out higher income
  • With-profit annuities: The income received from this type of annuity is linked directly to how well the investment strategy of the annuity provider performs.
  • Deferred annuities: This is also investment-linked, the difference being that any funds are left untouched by the account holder for an agreed period of time. During this accumulation phase, any funds within the account are exempt from tax.

To discuss the types of annuity products in more detail or to discuss which would be more financially beneficial for you, make an enquiry and we’ll match you with an advisor for a free, no-obligation chat.

Comparing different annuity types

Like many financial products, there can be advantages and disadvantages to each of the variations that may be available to buy.

Deferred vs immediate annuity

A deferred annuity is often seen as more of a long-term investment tool. After purchasing this type of annuity product, you don’t collect a payout until a specified date.

Within this period of time, the money in your annuity’s account could accumulate interest (if it is investment-linked) or benefit from market gains (if it is a variable annuity).

At the end of the agreed period, you can withdraw your money and use it for income or purchase another annuity product that provides a guaranteed income.

An immediate annuity provides an immediate income from the date of purchase or the date of the contract start date.

These annuities can be beneficial for retirees who want a guaranteed stream of income in exchange for a lump sum of cash.

Living annuity vs retirement annuity

A living annuity can come with potential risks as they are investment products.

Some retirees like the control they have over deciding which investments they get to invest their money in, while for others, this type of annuity may be too risky.

A retirement annuity pays out a guaranteed income for life, although a disadvantage to this type of annuity is that when you pass away, your capital is not passed on to your spouse or family.

Annuity alternatives

Annuity products can be a great solution for many retirees, but it may be the case that another retirement product could be more suitable based on your needs.

Annuity vs drawdown pension

Taking pension drawdown allows you to move your money into one or more funds and you may also have the freedom to decide on the amount you withdraw and the frequency of how often you can withdraw.

However, it won’t provide a fixed stream of income and there is also no guarantee that the money you drawdown will last you until you pass away.

Some retirees like the flexibility that a pension drawdown can provide them, while others like the peace of mind of knowing they are guaranteed an income from an annuity.

So, should you get a drawdown or annuity pension? Because there are so many factors that could affect how much you receive with an annuity versus a drawdown, it can be helpful to ask an expert to calculate each eventuality for you.

They have access to the current annuity or income drawdown rate tables and can use this information as well as your personal circumstances, to calculate whether an annuity or a pension drawdown is more beneficial for you.

Annuity vs term life insurance

Some people are unaware that some life insurance products may be able to offer a more suitable solution to their worries about not being able to leave an inheritance. For this reason, it can be helpful to consider the advantages and disadvantages of term life insurance versus annuities.

Depending on your health and life expectancy, term life insurance could be cheaper than annuity products. However, unlike annuities, they do not pay out an income.

Life insurance products are designed to leave a lump sum payout in the event of your death. The payout can be left to beneficiaries and used to pay off an existing mortgage, for living costs or to be spent as your beneficiaries see fit.

Should I take an annuity or lump sum?

A lump-sum payout from your retirement fund can seem appealing to those that wish to have full control over their finances.

However, there is no assurance that your pension fund will last from the date of retirement until your death and for some retirees, this can be troubling.

To discuss your options and learn the difference between a lump-sum versus an annuity pension, speak to an advisor by making an enquiry with us.

Is there a calculator I can use?

While there’s no calculator for pension lump sum vs annuities, the government website has a pension calculator that can be used to work out how much your lump sum would be.

For more information, speak to an expert who can provide you with more accurate calculations.

Annuity vs savings account

While it’s true that savings accounts can help some investors to gradually build their income, often the interest rates offered on these accounts can be low, meaning that any increase may not be of significant value or enough to boost your retirement funds.

Annuity vs investment bond

Although there are annuity products that are investment-linked, annuities are (in general) products which pay out a guaranteed income in exchange for an upfront fee.

Investment bonds can provide an alternative solution for retirees who seek to increase their retirement income.

Like any investment, bonds can be risky although it’s not uncommon for bonds to provide a slow and relatively low return.

Annuity vs stock market

For some retirees, stocks can provide a route for income growth. However, if you have a limited pension fund to begin with, this can be a very risky option for retirement.

If you had stocks and the market crashed or declined, you would be at risk of losing your investment and therefore your funds for retirement.

Some stock market investors can afford to live off their dividends, while others may have to resort to selling their stock for income, even if the market is bad and it means they make a loss.

The stock market can be an intense and stressful place for some, especially if the appetite for risk is low.

For those looking for the reassurance of a steady income, an annuity could be a better option but be sure to seek professional advice before you proceed.

Speak to an expert

If you’d like a clear insight into whether annuities are a good idea for retirement, get in touch and we’ll match you with an expert for a free, no-obligation chat.

The experts we work with can calculate whether investing in an annuity could be financially beneficial for you.

It may be the case that to find you the best deal, your advisor recommends an alternative retirement product instead of an annuity.

Call us on 0808 189 0463 or make an enquiry online.

We can arrange a free pension review for you today

70% of customers who have a pension review find a better deal

We can arrange a free pension review for you today

70% of customers who have a pension review find a better deal

Tony has worked in a vastly diverse array of areas in the pensions industry for over 2 decades. Tony regularly writes for trade press, usually on topical and pensions pieces as well as acting as a judge at prestigious national events. Tony is also a highly qualified Independent Financial Adviser in his own right. His mantra has always been "Hope for the best, but PLAN for the worst", and believes that the biggest impact that an adviser can have on a client's life journey is to take them on a journey from generally having little or no real idea of what their retirement will look like, to giving them the understanding of what their retirement looks like now, then helping them navigate a path to what they WANT their retirement to be.

Book a free, no-obligation pension review today