Advantages and disadvantages of annuities

Q: "What are the advantages and disadvantages of buying an annuity when you reach retirement age?"

Annuities take your retirement savings and turn them into a guaranteed income for the rest of your life. Whether this is right for you depends a lot on your personal circumstances and how you want to manage your retirement income.

As Fidelity wealth relationship manager Maria Gaita explains: “Annuities are a great way to cover essential expenditure in retirement. They provide a source of guaranteed income with no investment risk.”

Traditionally purchased using a pension fund, an annuity or Purchased Life Annuity (PLA) to give it it’s full name, can also be bought from savings.  A PLA will reduce the size of your estate, which is worth noting for inheritance tax planning.

Maria adds: “Annuities have been around for a long time and are easy to understand. They are covered 100% by the FSCS [the financial compensation scheme]. They require no ongoing maintenance, administration, ongoing advice, or charges.”

They sound like a win-win and indeed they do come with plenty of perks. One of which is that having a lifetime annuity will mean that you’ll never run out of money, even if you live to the grand age of 100. You also benefit from having a stable income which should help with budgeting, as you’ll know exactly how much money you’ll have coming in every month for the rest of your life. With some types of annuities, you can also protect yourself against higher levels of inflation with products that increase the amount paid to you in income, as inflation rises.

But as Maria cautions: “Annuities have a range of features which allow the annuitant [the annuity holder] to personalise their policy accordingly. Options include index-linked increases, spousal benefit and guaranteed periods.

“Each policy is personalised to the applicant’s personal circumstances (such as age and health). Therefore, some people may benefit from an enhanced rate of income. This could become quite expensive to have all the bells and whistles.”

It’s wise to consider the other potential drawbacks of buying an annuity as well, before you go ahead. For instance, when you purchase a lifetime annuity all that money is tied up, so you can’t access it again.

A lifetime annuity also means the rate you buy at, stays with you for life. As Maria explains: “You could potentially get a great rate depending on the annuity markets and rates due to the current interest rate, but this could also be a disadvantage as the rates could change and you may not have bought at the best rate if they were to increase for example after you have purchased your annuity.”

So, if you buy an annuity when rates are low you won’t benefit from potential increases in the future. Having said that you won’t feel a hit from falls in annuity rates either, but it’s important to realise that you’re generally locked in for life when you buy you annuity.

Because of this, some people opt to buy an annuity with just some of their pension savings. They can then keep the rest of their pension pot intact, so they can dip in and out of as they choose to. Others choose a fixed-term annuity, which offers a bit more flexibility as it only locks you in for a certain period of time.

The final thing to be aware of is that in some cases, buying an annuity will mean you’ll receive less income from your pension savings overall, than you would from pension drawdown.  If you buy an annuity and die sooner than the annuity provider projected, you will have received less money. It’s also worth bearing in mind that in most cases, annuities are treated differently to pensions when it comes to inheritance tax.

It’s worth seeking the help of an expert if you are thinking about whether an annuity might be right for you. The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

Our team of advisers can also talk you through your retirement options. If you are aged between 18-79 and have a minimum of £100,000 (which can include pensions) to invest, you can call them on 0800 222 550 or request a call back.

Our pension drawdown calculator can help you see how long your retirement income might last, if you keep some or all of your pension pot invested and take regular income from it (also known as flexi-drawdown). This tool is suitable for you if you’re aged 55 or over and ready to access your pension savings.

If you’re not there yet, you can check out our tips on getting ready for retirement.

If you’ve got a question of your own, you can ask the experts here.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.