Base rate hold offers a boost for annuity rates

The Bank of England confirmed last week that the base rate will be held at 5% for the time being, providing good news for retirees in the market for an annuity.

Here, we outline the current level of annuity rates, plus how the base rate and inflation impact the income you’ll get in return for your pension pot. 

What the base rate means for annuities

The decision to hold the base rate at 5% last week didn't come as a huge surprise. 

The drop from 5.25% in August had long been anticipated, but the Bank of England confirmed that any future decreases would be 'gradual'. 

Further announcements are due in November and December, and we may see another reduction before the end of the year. 

A stable base rate is helpful for potential purchasers of retirement annuities. An annuity allows you to swap some or all of your pension savings for a guaranteed regular income that will last for the rest of your life (unless you opt for a fixed-term product). 

After building up a pension fund using contributions, investment returns and tax relief, individuals over the age of 55 with defined contribution (DC) pensions can use the money to buy an annuity.

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What impacts annuity rates?

The exact amount you'll earn from an annuity depends on the rate a provider offers you. 

Providers consider economic factors and your personal circumstances (for example your age, location, life expectancy and health) when pricing an annuity.

Annuities are 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. Providers fund their annuities with these bonds and gilts because they're among the safest types of investment. 

When the Bank of England base rate and inflation are low, gilts become more expensive and the rate of interest (or yield) falls. Lower yields result in lower annuity rates, and vice versa. 

Annuity rates can fluctuate frequently, so getting the most from your pension pot can be about getting the timing right. 

• Find out more: best annuity rates

How rates have changed

Rates on annuities remained in the doldrums from the credit crunch at the end of the 2000s, through the Brexit vote in 2016 and the pandemic in 2020 and 2021. 

High inflation during 2022 and 2023 saw the Bank of England hike its base rate on numerous occasions – it climbed from 0.1% in November 2021 to 5.25% in August 2023. This had a positive effect on annuity rates. 

A 65-year-old with a £100,000 pension received around £5,000 per year from a single life level annuity in July 2021 (according to figures from Hargreaves Lansdown). 

In the aftermath of the mini-Budget in September 2022, this had risen to £7,600 per year. The current level for a 65-year-old is around £7,150 per year after the base-rate cut last month.

Further base-rate reductions appear likely, although not at the same speed as the rises in 2022 and 2023. This means falls in annuity income should therefore be much more gradual. 

The table below gives an idea of how much a healthy 65-year-old with a £100,000 pot might get. 

Source: Money Helper annuity calculator, correct as of 23 September 2024. Figures are based on a person living in a CB23 postcode receiving payment annually in arrears, and are to be used as a guide only.

Annuities and inflation

Linking your annuity to inflation means that your income grows over time. This option could be worth considering. 

If you're looking into an annuity that increases in line with inflation (RPI) every year, a 65-year-old can currently get up to £4,468 per year if they have a £100,000 pot, according to the latest data from Hargreaves Lansdown. This is much lower than the £7,150 available for a single-life annuity.

This can leave you with a tricky decision. Do you opt for the lower starting amount, which will rise over time, or do you go for the higher one and hope inflation doesn’t go up significantly during your retirement?

• Find out more: inflation remained at 2.2% in August

How do I get the most from an annuity?

If you decide an annuity is right for you, there are some additional things to consider.

First, it's still worth shopping around, even though there are only six or seven providers offering products at the moment. They all price differently, so if you just accept the first quote, you may be getting 10% less than the best offer available. 

A broker will assess all the products on the market for you. Once you arrange an annuity, you can’t reverse the process and claim your money back. It therefore pays to see what the whole market can offer before taking the plunge. 

Consider which type of annuity might be suitable for you. For instance, single-life annuities offer higher incomes than joint-life ones, but the joint-life product will offer an income to your spouse should you die first.

The more details you can provide about your health and lifestyle, the better. For example, if you have had a stroke you could push up your income by 18% per year, while someone who smokes 10 cigarettes a day could be in line for a 7% increase via an enhanced annuity.

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