A Rare Financial Guarantee – The Annuity Explained

Certainty can be elusive. Especially these days. And especially when it comes to your money. Everything seems to be loaded with caveats. Aside from the promise on that ten pound note you found the other day (“I promise to pay the bearer on demand the sum of ten pounds”) are there any others? Well, yes: Can we introduce you to the annuity?

Income, Guaranteed

You work hard, save and invest for decades, topping up your retirement pot – and you might think the moment you start drawing from that pot would be joyous.

But it’s not always the case. Retirement depression and stress is a very real thing.

Wouldn’t it be nice if there was some certainty to counterbalance all this? A rare guarantee from a financial services industry which uses words like ‘may’, ‘potentially’ and ‘could’?

The annuity is just that. It is a financial product that guarantees you an income for life. And last year almost 90,000 retirees purchased one.

There are of course lots of ways to pivot from accumulating money to decumulating it, from saving to spending, from growth to income. We talk with clients about these options all day, every day.

Part Simple, Part Complex

You did read that line above correctly. An annuity guarantees you an income for life. Let us explain.

A pension is something designed to grow. It doesn’t have an automatic ‘income’ component … there’s no tap to empty the tank. So, you need to bolt one on. That’s what annuities are for. If you have, say, £1m and buy an annuity with a rate of 5%, your income will be £50,000 before tax.

But this is where annuities can get complex. One reason is that your income is calculated with reference to British government bonds. These go up and down.

At the moment they’re up. Aviva is a big annuity provider and they have a handy chart showing that, these days you could get an income of 7% or more. A few years ago, it was sub 5%. Go back further and you’d find bond rates on the floor and annuities paying you a pittance.

The boffins at these insurance companies use all sorts of other calculations of course: your age, health, life expectancy and so on.

Product Types

The second way in which annuities are complicated – and which can really bamboozle people – is that they come in all shapes and sizes.

Here are four of the main different types:

• A level annuity will pay you a fixed, guaranteed income of money for the rest of your life. These tend to pay out around the 7% we mentioned above.
• Enhanced annuities can pay you a little more. This is because they’re for people with certain health conditions who may not live as long (i.e. the same pension pot gets divided into a smaller number of larger payments over the remainder of the person’s life).
• An escalating annuity pays an income rising by a fixed percentage. At the start of owning an annuity, your income will be lower than the level annuity’s 7% but it will push through that and increase over time.
• An index-linked annuity pays an income rising with a measure of inflation. Again, early payments are lower, later ones higher.

But that’s not all. Annuities come with bolt-ons.

• For example, an annuity dies with you. You can’t pass it on to your descendants… unless you get value protection, which pays a lump sum balance to a beneficiary or dependent upon death.
• And then there are annuity guarantee periods, which do something similar, by diverting income payments to a loved one after your death.

No one knows when they’ll die. But, if you live long enough, there’ll be a point in your annuity’s income payments where you’ve got your money back and all future income is “free”.  

All this complexity and the sheer volume of products mean it’s essential to shop around. There will almost definitely be something just right for you. Which is, essentially, what we talk about with clients.

If you’d like to know more about your options for the future or, if you’re approaching retirement and such decisions feel quite close, then get in touch. We’d love to share our expertise. You can reach us at hello@firstwealth.co.uk or on 020 7467 2700.

Annuities are long-term, complex financial instruments that may not be suitable for all investors. All investments carry risk, and annuities are no exception. The performance of an annuity is not guaranteed and can be affected by market conditions and other factors. It is essential to carefully consider your financial situation, investment objectives, and the product’s fees and restrictions before purchasing an annuity.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.