Options for cashing in your pensions
By Paul Davies
Article 4 of 5
We identify the factors that will determine the rate you’d get on an annuity. This guide explains how annuity rates work.
Annuity rates determine the amount of regular income you will get in return for your pension savings. They are usually shown as how much money you’ll get per year for every £10,000 you pay in.
For example, an annuity rate of 5% would mean you’ll get £500 for every £10,000 you invest – so if you gave your annuity provider £50,000, you’d get £2,500 a year.
But what influences annuity rates generally? This guide explains how they work.
Annuity rates – how are they calculated?
1. Life expectancy
Annuities work like insurance – all the customers’ money is put into a pool and paid out until the term ends (when you die). This means that people who live longer get a bigger share, and people who die sooner get a smaller share. This is reflected in annuity rates. The longer you’re expected to live, the lower your rate, because the provider will be paying you for longer.
2. Your health
This is linked to your life expectancy. If you’re in poor health, smoke or have another lifestyle condition, you’ll be expected to live for a shorter time, so you’ll get a better annuity rate. Enhanced annuities work on this basis and can secure you up to 30% more income.
Go further: Enhanced annuities – find out more about the ways these annuities can boost your income
3. Interest rates
The lower interest rates are, the lower annuity rates are. This is because pensions are partly funded by the interest earned when your money is invested, so you’ll get less for your money when rates are low. Currently, the base rate is just 0.25%, so annuity payments have been reduced.
Go further: Savings accounts – see how much you could earn using Which? Money Compare savings and Isa comparison tables
4. Gilt yields
Annuities are also partly funded by government bonds (known as gilts) which insurers buy. In return, the government pays the insurers a fixed amount of interest, which is tied to the base rate and inflation. So when the base rate and inflation are low, gilts are worth less, causing annuity rates to fall.
Go further: Corporate bonds and gilts explained – find out how these investments work
5. Not your gender
Until 21 December 2012, insurers were allowed to rate annuities based on gender. Women have longer life expectancies than men so were given worse rates. However, the EU gender ruling found that any difference between men and women when buying insurance was unfair, so it’s now illegal to offer different annuity rates.
- Last updated: March 2016
- Updated by: Paul Davies