First of all the good news; annuity rates give us the best deal since we had an economic collapse in 2008.
Annuity rates have reached an 18-year high of 7.75%, according to the Standard Life Annuity Rate Tracker.
Second of all the number being touted as the “pot to pension” convertor needs some understanding.
The rise means a healthy 65-year-old with a £100,000 pension pot could expect to receive up to £7,750 per annum, compared to £7,660 in April. That could work out to an extra £2,060 over the course of retirement.
I will, in a couple of months be a 65 year old male in reasonable health and I hope to be around for 25 years to come. In 2051, assuming inflation between now and then of 3%, the buying power of £100,000 today will have fallen to £47,761 (spurious accuracy I know). If inflation is 5% pa till I pop my clogs , then the buying power of £100,000 today will be £29,521.
Am I really risking my “pay” falling by between 53% and more than 70%?
Even if the Government met its target of 2% inflation over the next 25 years, I would see my pay fall by nearly 40% (in inflated adjusted terms).
The story may be good compared to recent times but really?
Really? In real terms the fall in value of income through to death is even worse for those who are 60. It’s not quite so bad for those who are 70. The greater improvements for “young” 60 year olds is because level annuities benefit more than changes in later life, there is less to lose from no “real” pay. These figures are “unreal”.
So is all this
Pete Cowell, head of annuities at Standard Life, said: “Annuity rates have reached the highest rates since August 2008, underlining just how much the retirement income landscape has shifted in recent years.”
It of course reflects the market view that inflation will go up faster than expected.
He said that at today’s rates, the time it takes to receive back the initial investment has significantly shortened.
Only if you take inflation out of the calculation
The payback period for a £100,000 annuity purchase with a rate of around 5% in 2020 would have taken around 20 years to repay. However, with today’s rates closer to 7.75%, that falls to around 13 years, depending on individual circumstances.
This “payback period” is of course why only 10% of us buy annuities. It is hard for us to get the concept of being repaid our money. This is why the “pot to pension” story is so hard for us to buy – why “money purchase” died out in 2014 and why Retirement CDC will be part of the problem.
According to the Tracker, a healthy 65-year-old male who bought an annuity in July 2026 at a rate of 7.75% could expect a total lifetime income of £156,000. For a female of the same age, the expected income was £177,000.
These numbers are feeble compared with the projections offered on drawdown. That is because annuities guarantee things and investments don’t. The gender difference (in favour of women is because the European Union required insurers to quote the same annuity rates for women and for men. It is the one thing that has been done to ease the pension gender gap as women tend to live longer.
Meanwhile, a healthy 70-year-old who bought an annuity during the same period could expect a rate of 8.43%. For a man, this would provide a total lifetime income of £135,000 while a woman could expect to receive £155,000.
Anyone reading this far will have worked it out that “flex and fix” may seem a good idea, holding on to investment growth till you are 70 or later means a higher guaranteed in later life.
Standard Life, who are behind this article in Financial Planning offer us this summary
Their commentator (Peter Cowell) concludes
“Trying to predict how the market might perform can be difficult and while rates have remained elevated over recent months, planning ahead is key.”
That’s true, but one prediction that I have for my next 25 years is that we will have inflation and likely more than the Government target of 2%.
We all know the argument that’s being had about whether we have a triple or a double lock but nobody suggests that the state pension is paid with no increases at all.
For most people, a pension is an income that keeps up with inflation and there is no reason why Standard Life could not show the income levels we’d have from the Standard Life Index if the annuity was paid with fixed increases or inflation linking.
The annuity story is unreal. The failure to explain the impact of building inflation into the annuity rates paid is tantamount to mis-selling. CDC will quote inflation linking on the wages it pays to people in retirement.
Ancient advice: in life they tax income so try to convert income to capital. In death they tax capital so try to convert capital to income.
So there’s a tax case for annuities before you even try to grasp what their point is, namely risk-pooling with other people in your age cohort. Is it really so hard to grasp the idea of longevity insurance? Apparently it is. There’s even a name for the irrational hatred of annuities: “The Annuity Puzzle”.
The annuity puzzle indeed describes an apparent contradiction in behavioural economics.
Life-cycle models predict that people should widely buy life annuities to guarantee lifetime income and protect against outliving their savings.
Yet, in practice, few retirees voluntarily purchase individual immediate annuities, preferring to live off other savings or ad hoc lump-sum withdrawals.
Annuities are said to
insure against longevity risk, meaning you cannot outlive your money. Unless you buy a fixed term
annuity.
There is even arguably a “mortality credit” as pooled funds at least in theory redistribute money from those who die early to those who live longer, offering higher payouts than standard investing might.
But many people tend to underestimate their longevity and/or their luck, so fearing they will die earlier (being unlucky) perhaps creates reluctance to reward others (the lucky ones) who live longer?
Modelling suggests people should convert all or most retirement wealth into annuities.
But Warren Buffett in his 2008 letter to shareholders wrote: “Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the models. Beware of geeks bearing formulas.”
Reasons why people may avoid annuities in practice? Are they being irrational?
Bequest motives. Retirees want to leave money or an inheritance to their children or heirs or favoured charities.
Or liquidity preference. Locking money away in annuities prevents access to lump sums for unplanned events, unexpected emergencies or health care costs.
Or loss aversion and framing. Many retirees may view annuities as a risky financial bet rather than steady monthly spending insurance.
While they’re unlikely to describe it as “counterparty risk” many seem
to fear that the issuing insurance company or provider could face financial trouble down the line.
Our media’s tendency to report and emphasise bad news (the exceptions, things that happen to individuals) rather than emphasise safeguards and other support mechanisms (which operate in favour of the vast majority as a rule) is responsible for at least some of the negative framing.
The aphorism “in life they tax income …” captures a useful instinct that the optimal tax planning characterisations change over your lifetime, but it mistakes tax character for economic ownership.
During life, lower-taxed capital treatment can genuinely be very valuable.
At death, the question is not so much whether your wealth was called “income” or “capital”, it’s whether your estate still owns it, what exemptions and reliefs may apply, and how CGT rebasing, IHT, pensions, spouse exemptions, gifting, and past spending interact.
While simply reclassifying retirement capital as income without disposing of it accomplishes little or nothing for IHT purposes, and it may trigger unnecessary income tax sooner or later along the way.
A Bean Counter’s breakdown of that misleading Standard Life Number.
The Break-Even Payback Hurdle: You must live at least 13 years just to recover your original capital (£1/7.75%= 12.9). Up to this point, your gross rate is negative because you have not recovered your principal outlay.
The “Mortality Credit” Shift:
If you die early, the insurance company keeps the remaining capital, resulting in a negative return for your outlay.
If you outlive average life expectancies (20+ years from
age 65), you could benefit from “mortality credits” (subsidised by those who died early), driving your true rate earned closer to maybe 5%.
Underlying Asset Matching:
I think insurance companies back lifetime annuities primarily using long-term government bonds and gilts.
As long as those institutional yields sit lower than the quoted payout, as they do currently, the gross return of a 7.75% annuity can never mathematically match 7.75%, unless you survive well into your late 90s.
In the UK of course, payments from a lifetime annuity bought with a pension pot are treated as earned income. Your provider or scheme administrator will presumably deduct income tax using the PAYE system before sending you the money.
And because the full State Pension (£12,548 a year for 2026/27) already consumes almost the entire £12,570 tax-free Personal Allowance, virtually any extra annuity income you receive on top will push your total earned income past the threshold and be fully taxable at your basic marginal rate of 20%.
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