THE BIG MONEY QUESTION: Should I buy a retirement annuity?

In a new series, we answer YOUR burning questions about money…

Should I take out an annuity with my pension savings?

I would like the security of one, but stayed away because I thought they weren’t good value for money.

However, I was told that the rates were improving. AC Leeds

Rachel Rickard Straus and Ruth Jackson-Kirby respond: Annuity rates are rising at their fastest rate in more than 30 years – so it’s understandable that you might wonder if they’re finally worth revisiting. Annuities allow you to exchange a lump sum of your retirement pool for guaranteed income for life.

They offer the assurance that even if you live several decades after retirement, your income will never dry up.

Even so, until recently, annuities had fallen out of favor, as the annual income they provided had fallen to historic lows. Now they are on the rise again. Average annuity rates have increased by up to 24% over the past year.

A 65-year-old man with no serious medical conditions who took out a single life annuity with £100,000 around this time last year would have bought an annual income of £4,905. Today, £100,000 would bring you an income of £6,083, according to annuity expert William Burrows of The Retirement Planning Project, or an additional £1,178 every year.

Rebecca O’Connor, head of pensions and savings at investment platform Interactive Investor, says: ‘Because annuity rates have been low for several years, they have been written off by new retirees. But the tables can now turn.

Annuity providers – insurance companies – take your lump sum and invest it to produce income.

They tend to invest in bonds because they are low risk and provide reliable income. But bond yields have reached historic lows, limiting the amount annuity providers can offer buyers as annual income. As bond yields have risen this year, annuity rates have also risen.

But they are likely to increase further. Indeed, the Bank of England should continue to raise interest rates to curb the surge in inflation. As the base rate rises, so should bond yields.

Once you’ve purchased an annuity, it’s permanent – ​​you can’t renegotiate a better rate later. Still, if you want the reliability that an annuity provides, there’s a way to do it without giving up flexibility. It involves buying several annuities at different times during your retirement.

This gives you peace of mind that you won’t fall into retirement poverty, but it also means you haven’t locked all of your retirement savings into a single annuity.

Helen Morrissey, analyst at wealth management platform Hargreaves Lansdown, says: “A good strategy might be to build in installments over your retirement. This means you could leverage part of your pension to generate income to cover day-to-day expenses while leaving the rest invested so it has the potential to grow.

One option is to purchase an annuity that covers your basic living expenses for life, and then invest the rest of your pension more flexibly.

A single person needs around £10,900 for a basic lifestyle in retirement, according to the Pensions and Lifetime Savings Association. The state pension gives an annual income of £9,628. Therefore, to make up a shortfall, a 65-year-old man would need to take out an annuity of £25,000. This would provide an annual income of around £1,400.

Remember that the older you are when you purchase an annuity, the higher the income you should receive.

If you opt for an annuity, you must make several decisions that will affect your level of income. First, you can choose between a level annuity – which pays a fixed amount each year – or an indexed annuity, which increases your income each year with inflation.

With inflation soaring to more than 9% per year, the latter option seems desirable. But they are extremely expensive to buy. If a 65-year-old man bought a single annuity with £100,000 he could get £6,083 a year without inflation protection – but only £3,479 a year if he wanted the income to grow each year with the measure inflation by the retail price index.

William Burrows says: “For most people, the state pension is the foundation of their retirement income. This, by definition, is protected from inflation. Therefore, it usually doesn’t make sense to pay extra for an annuity with inflation protection because the cost is so high. If you find that your income is eroding over the years and you need more income later in life, equity release may be an option if you own your home.

Second, you need to decide whether you want a single pension – which will be paid until your death – or a joint pension, which will be paid until you and your spouse die. If the designated annuitant dies, the income is generally reduced by one-third or one-half.

Finally, consider whether you can obtain an enhanced retirement pension. These pay a higher income to people who have health problems – and whose life expectancy is shorter than average.