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An annuity turns your ‘defined contribution’ pension pot into guaranteed income, either for life or for a set period. There are other ways to take money from your pension, like pension drawdown, but an annuity can be a good choice if you want certainty: your payments won’t be affected by the ups and downs of interest rates or the stock market.
Each annuity provider calculates a personalised annuity rate based on your own unique set of circumstances. That means two people with the same pension savings could get very different income offers.
Your annuity rate is the key to how much income you receive from your annuity. For example, if your pension pot is £100,000 and your annuity rate is 5%, that gives you £5,000 a year. If the rate is 6%, your income jumps to £6,000.
Personal factors that influence your annuity rate
Providers will consider several personal details when working out your rate:
Your age
The longer a provider expects to pay your income, the lower your annual payment. That’s why older people usually get higher annuity rates: the provider generally expects fewer years of payments.
Your health and lifestyle
Certain health conditions or lifestyle factors may qualify you for an enhanced annuity, also known as an impaired life or underwritten annuity, which pays more. Even conditions under control, or taking medication, can boost your income. Giving full and accurate information is vital, as under-disclosing can cost you money.
Enhanced annuities are only available on a lifetime basis, and not for fixed-term annuities that run for a set period of time.
Your occupation, work history and postcode
Providers also look at your job, your career history, and where you live. These can subtly influence life expectancy, and therefore your annuity rate.
The annuity options you choose
Choosing certain optional features can change the amount you receive. For example, with an escalating income option,your income starts lower, but will increase each year, either linked to inflation or at a fixed rate.
Also, you can choose to add death benefits to your annuity. This would provide a lump sum or ongoing payments for a spouse or other beneficiary. This typically reduces your own income, but provides financial protection to your loved ones.
Economic and provider factors
Your annuity rate isn’t just about your personal details. Providers also take a close look at the wider economic environment and their own commercial considerations. Rates can fluctuate day to day depending on economic conditions, gilt yields and a provider’s business decisions.
Gilt yields and interest rates
One of the main factors affecting annuity rates is government bonds, also known as gilts. Annuity providers invest in these to fund the guaranteed income they pay out. The interest (yield) they earn on these bonds has a direct impact on the annuity rate you’re offered.
When interest rates go up, gilt yields tend to rise, and annuity rates often follow suit, meaning you could get a higher income. Conversely, when rates fall, gilt yields typically drop, and the annuity income you are offered might be lower.
Even small changes in the economy can shift annuity rates, which is why shopping around at the right time can make a real difference. But remember, once your annuity is set up, changes in the economy will not affect you, since the annuity rate is set for the life of the annuity.
Commissions and fees
Like most financial products, annuity providers charge for the service they offer, but instead of separate fees, these costs are built into the annuity rate. The same often goes for any commission paid to a broker who helps arrange your annuity. This is often also reflected in the rate you’re offered.
What is a guaranteed annuity rate?
If your pension scheme includes a guaranteed annuity rate (GAR) – often on older pensions set up before July 1988 – the rate and income it offers could be higher than what’s available on the open market today.
Even so, it is recommended that you do compare annuity rates available elsewhere, just to make sure that you make an informed decision about your pension income.
Getting the best annuity rate for you
Annuity rates differ from provider to provider, so shopping around could make a real difference to your retirement income and lifestyle. Our annuity partners Retirement Line compare rates from the UK’s leading providers, helping you find the annuity that gives you the most secure and suitable income in retirement.