Blog » The role of annuities in retirement planning

The role of annuities in retirement planning

February 6, 2023
The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article.

Suppose you are chatting to friends or family about retirement planning. In that case, you will come around to discussing pensions and how much you might get when the time comes to stop working. However, what is not quite so common are conversations about the role of annuities in retirement planning. 

This was not always the case. Indeed, buying annuities used to be the only choice for people with defined contribution pensions. With the introduction of pension freedoms in 2015, this changed, and pension holders got more options. These include cashing-in their pension pot, drawing it down, or buying an annuity.

This article aims to inform you of the types of annuities to consider in your retirement planning, their benefits, and their potential drawbacks. 

What is an annuity?

Annuities are a type of insurance product that enables you to swap your pension pot for a guaranteed income for a set period. The amount you could receive depends on the type of annuity you opt for and the rate offered by the provider. 

The insurer is taking the risk that they will not end up paying out more than the total value of a pension. Therefore, they will often offer higher rates to people with severe health conditions than those with many years ahead of them. 

Depending on your situation, buying an annuity could make sound financial sense. Let’s look at the types available.

Main types of annuities

Annuities perform better as interest rates increase, which is something to consider as you plan for the future. Of course, you’ll want to ensure you get the best deal, so it is worth understanding the various types of annuities available and their benefits and potential drawbacks.

Fixed annuity

Fixed annuities pay a fixed income for a set period, generally 5-10 years, but they can be as much as twenty. As people have certainty about how much they will get each month and for how long, annuities are an attractive investment opportunity for many. 

In most cases, you can receive your income monthly, quarterly, or annually. The amount you receive from an annuity depends on its interest rate, length, how much you pay into it, and your age and health.

When the annuity period has elapsed, the provider pays you a sum known as the ‘maturity amount’ that you can withdraw as a cash sum. However, many use this payment to purchase a new annuity. Alternatively, some choose a fixed-life annuity that guarantees an income for life.

The provider invests the money you pay for your annuity at a fixed growth rate. This allows them to pay you a regular stream of income while also ensuring the annuity is viable for them.

Variable annuity

Variable annuities are more common in the United States, but they are increasing in popularity in the UK. They offer you a balance between a fixed-rate annuity and pension drawdown, making them something you might consider to diversify your investment portfolio.

Similar to fixed annuities, variables offer you either a lifetime income or for a set period while retaining control of your funds. You also can decide where you want your money to be invested. 

family alfresco dining | Annuities in retirement planning

A key advantage of a variable annuity is that your funds continue to grow when you retire. Of course, the markets can also drop. Variable annuities take this into account. They allow you to protect yourself with risk management, such as locking in investment growth.

Benefits of annuities for your retirement

One of the most significant benefits of an annuity is that it provides you with a guaranteed income for a set period. This certainty appeals to many people as it allows for security and aids financial planning. 

Annuities are linked to interest rates, which are used to control inflation. Therefore, buying an annuity can help safeguard your money against price rises. Similarly, stock market fluctuations can affect your retirement income; annuities can offset such economic dips. 

In certain circumstances, an annuity can provide you with significantly more income than you would have otherwise. For instance, if you are in poor health. 

Potential drawbacks of annuities

Of course, there are also a few drawbacks to annuities. Therefore, you should consider all options before investing in an annuity. 

You might receive a higher income if you have a short life expectancy. However, you could lose a more significant proportion of your retirement funds. 

If you rush into an annuity without fully considering all your options, you might regret it long-term. Remember, your funds are locked into an annuity for a set period, often for the rest of your life. If you change your mind, you may have no option for getting out.

Similarly, not all annuities are the same. Depending on your chosen annuity, you could lose up to £71 a year. Therefore, ensure you shop around for the best deal. 

With a fixed annuity, you lose control of how your money is invested. Many people want to have a say regarding their investments. If you are one of these, a variable annuity or other option may be better. 

Seek advice

As with other aspects of your retirement planning, annuities can appear complex. Getting things wrong could mean you end up with a poor deal, your money being locked up, or your retirement funds getting invested somewhere you don’t want.

As such, it is a good idea to seek regulated financial advice before making any decision regarding your retirement funds. They can help you assess your financial situation, discuss the role of annuities in retirement, and ensure you make an informed and considered decision.

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