With annuity rates going up, are these now a better option versus staying invested through drawdown? Especially given the level of volatility we’ve been seeing recently in the UK?

Emily

Tom Selby, AJ Bell Head of Retirement Policy, says:

If you are a defined contribution (DC) saver building up your own retirement pot, there are broadly three routes available when turning your fund into a retirement income. Usually, you must be aged 55 or over to access your pot, with this ‘normal minimum pension age’ set to rise to 57 in 2028.

Drawdown is the most popular option chosen by UK retirees, with more than 205,000 people entering drawdown in 2021/22, a 24% increase on the previous year.

If you enter drawdown, your fund will remain invested and you’ll have total flexibility over how and when you access your money. This flexibility comes with responsibility – namely ensuring your fund lasts throughout your retirement by managing withdrawals sensibly. You also need to be comfortable with the risk your investments might fall as well as rise, particularly in the short term.

Buying an annuity is the next most common route, with over 68,000 annuities bought in 2021/22, up 13% year-on-year. An annuity is simply a guaranteed income paid by an insurance company for the rest of your life in exchange for a lump sum payment.

This provides greater certainty than drawdown, with the price of certainty a loss of flexibility and the potential to enjoy long-term economic growth.

Annuities can be level or ‘escalating’, meaning they rise each year by a certain percentage. If you buy an escalating annuity, the initial income you receive will be lower. It’s vital when buying an annuity you shop around the market and tell your insurer of any medical or lifestyle factors that may limit your life expectancy, as disclosing these could mean you get a better rate.

Finally, you can take ad-hoc lump sums from your fund, with a quarter of each lump sum tax-free and the rest taxed in the same way as income. Almost 20,000 of these payments were taken last year.

For over a decade, annuities have been in the doldrums, in part because gilt yields – which largely determine the rates offered by insurers – have remained persistently low. The flexibility available for drawdown investors has also proven hugely popular since the pension freedoms were introduced in 2015.

However, rising gilt yields this year have boosted annuity rates, with reports of rates improving by 40% to 50% since the start of 2022.

Rising annuity rates of course makes them a more attractive proposition, but it’s important when making a choice you consider all relevant factors. Questions to ask include:

– How much do you value flexibility over security?

– Could your income needs change in the future?

– How old are you?

– Are you in good health?

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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