Pension savers approaching retirement may benefit from locking into an annuity as rates continue to climb. According to the BBC's Money Box programme, at age 65 a £100,000 pension fund can now be converted into a fixed income of "more than £8,000 a year", described as "the highest it's been for most of this century".
Independent financial adviser Billy Burrows, from The Annuity Project, explained how annuities work on the programme.
How annuities work and current rates
Mr Burrows told the programme: "An annuity converts capital into income for life. Any payment has two elements: one is return of capital, and second is interest. And it's the interest rate that has increased in line with the increase in Government borrowing."
Top annuity rate figures from Hargreaves Lansdown as of October 15 showed that for a £100,000 pension used to buy an annuity, you could get £8,211 a year at age 65 for a single life, level, no guarantee annuity. The 'level' term means that payments stay the same each year, even while the cost of living increases.
If you took out a similar annuity at age 65 but with a 3 per cent increase to your payments each year and a 5-year guarantee - meaning your payments would last at least five years even if you die before then - at the top rate you could get £6,094 a year. 'Single life' means the payments only cover one person and the payments last the rest of your life.
Age and tax considerations
If you took out the same single life, level, no guarantee product at age 70, you could get a £9,002 annual income. If you took one out at age 75, you could get £10,212 a year.
Annuity income is subject to tax in the same way as your other pension payments. You can take out an annuity from the age of 55, the same age when you can access most private pensions. This access age is increasing to 57 from April 2028.
Why now is a good time
Mr Burrows explained why now is a good time to think about getting an annuity. He said: "Now is a good time because rates are high, and also because the stock market is quite high and there's uncertainty in the future, so locking into guaranteed rates makes sense."
You can go for a single annuity with a payout for just one person or a joint option. The financial expert said: "Single or joint—if you're married or have a partner, it makes sense to have a joint life annuity, so if you die first, the income continues. The second option is increases.
"Some people prefer a level annuity, and if you're more prudent, you'll have it linked to RPI, increasing with inflation." The other question is if you want a guarantee period on your product. Mr Burrows said: "I call that insurance against dying soon after buying the annuity; you can have the income guaranteed for 5 or 10 years."
Using annuities to reduce tax liability
One listener called Duncan wrote into the BBC show to say he is in his 70s and is buying an annuity to help reduce his inheritance tax liability. He is likely planning to then make gifts out of his surplus income from his annuity.
Mr Burrows said: "This is the normal expenditure out of income exemption, and HMRC needs to be satisfied that the income you're gifting is surplus to requirements." He said an annuity can be particularly "helpful" as a means to trim your inheritance tax bill as "it should be easy to demonstrate that it's surplus income".
But he did warn that this may be a pointless endeavour depending on what tax band you are in. The expert said: "You pay tax on the income anyway, so if you're a 40 per cent [higher rate] taxpayer, you'll be paying 40 per cent income tax on income that you're gifting away to save 40 per cent."
