Annuities emerge from doldrums as interest rates rise in UK

Annuities are back in the spotlight, with rising rates after a number of years in the doldrums.

At the point of retirement, pensioners have two key choices with pensions – to take out an annuity, or to go into “drawdown”.

An annuity is when you exchange your pension savings for a fixed ongoing annual payment. They provide certainty.

By contrast, a drawdown pension can remain invested and you choose what to take out of it, and when. They do not provide certainty but they do offer flexibility.

Annuity providers typically buy Government bonds to generate returns.

When interest rates are very low – as they have been over recent years – these low rates push the returns of Government bonds down.

This, in turn, dampens annuity rates offered to pensioners.

Interest rates have risen to 2.25 percent in the Bank of England’s efforts to curb rampant inflation, a global phenomenon largely triggered by the increase in energy costs.

This has given annuity rates a welcome boost and rates today are about 35 percent higher than they were just 12 months ago.

By way of example, a healthy, single 65-year-old with £100,000 in a pension could get a lifetime annuity income of about £6,800 per year today. A year ago this would have been nearer £4,900.

The story is not over yet. Last week, the Chancellor’s dramatic mini-Budget cut taxes and set the scene for extensive future Government borrowing – which in turn means issuing many more bonds.

The markets took fright and sold off Government bonds. The interest paid on these soared, as lenders needed more reward to lend to a riskier-looking UK Government.

The market forecasts higher interest rates ahead – with some predicting a rate of 5.5 percent by next summer.

This all points to continued growth in annuity rates, which are set to keep rising over the coming months as the Bank of England continues to fight inflation, and as the Government’s borrowing requirements grow.