Pension worries - can anyone explain annuities?

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Bit worried currently about pensions due to big drops in my small DC fund. I was hopefully going to have a DB pension but unfortunately am unwell after the pandemic and may not be able to return to work. I had planned to work for another 10 years. I know the outlook for the stock market is not great but I read somewhere that increasing interest rates might help annuity rates? Does that mean you need a smaller pension pot? (with apologies to those with big mortgages for whom I know interest rate rises are very scary).

Very basically, you divide your pension pot by the annuity rate to get the annuity level (i.e. the amount the annuity provider will pay you each year in return for you giving them your pension pot).

For example, if your pension pot is £100k and annuity rates are 5%, they will pay you £5k each year. If annuity rates go up to 10% then you would get £10k per year from the same pension pot (or alternatively you would only need a pot of £50k to provide £5k income).

So yes, as annuity rates go up you need less money to buy the same amount of annuity income.

What you get from an annuity is fixed forever though - some will go up annually with inflation but if your annuity is based on it 3% will stay at 3% forever, even if interest rates go above this.

many people are now using their pension as a big savings pot to draw on - called drawdown. The remaining capital goes up and down with the financial markets, you take out what you need as you go along. It’s a bit more scary - especially times like now - when the markets are down but over time does balance out.

make sure your national insurance is maximised so you get the full state pension when the time comes.

We are close to having to take our pensions as bothme and partner are almost 70. Looking at annuities, I will have to live to 95, just to get back the value of the pension pot, and if I die before 95, the surplus goes into the coffers of the annuity company. On the other hand. If we take a drawdown pension there is the risk of the pot running out. But if I die before the pot is empty, the surplus will go to my dependants. Now, if annuity rates rise, it may be worth going that route instead of drawdown. We will have to see what happens to rates over the next few years.

Thank you for the explanation

Annuity rates are at 14 year highs. At current levels it will take the average annuity rate at age 65 about 15 years to break even.
lincslady53 - you should get a new quote - at age 70 it will pay back the full amount much quicker than at age 65
it is a guaranteed return for life which no investment can provide - the risk is that you die ‘young’ and there will be nothing to leave to beneficiaries
it is possible to build in a guarantee period which is not necessarily much more if it’s for up to 10 years

Watching this thread with interest. Don't know much about annuities but there definately seem to be some interesting and much improved products around.

I'm single so theres noone else for me to discuss this sort of thing with - I just don't know what to do for the best. Have about £200k in pension.

Another option that might give greater flexibility is a fixed term annuity. After the fixed term you receive a guaranteed lump sum.
So it would be possible to buy an annuity up until the time the State Pension kicks in, then decide what to do with the lump sum depending on circumstances- reinvest, or buy another annuity, perhaps.

You say you might not be able to return to work but do you already have some service built up in a DB scheme? If so that is effectively the same as an annuity (in that you get a fixed yearly amount).

Very interesting I've been wondering about annuities for a while too 👀

It is also possible to do a combo of an unity and draw down

Thanks - that is interesting especially the fixed term annuity. I do have some DB benefits but not as much as hoped as I worked part-time around children etc. I have maybe 28 years in my state pension. I am lucky though as own my house so downsizing is an option. And hopefully I can work at something sometime if I can't return to previous career.

Also another question - do you have to use pension fund to buy an annuity or can they be 'bought' with savings

You can buy top-up years for your State Pension if you don't have a full entitlement - best done once you have decided to stop paid employment so you don't buy more than required, and take advice form a contributions expert at the DWP.

You can also use your savings to buy an annuity, not just a pension pot. But of course you won't get the benefit of the 20% tax relief payments on the savings before you put it into an annuity.
If you're not working, you can still drip feed savings into a DC pension - up to £2880 each financial year which will still receive the government top-up tax relief payment to £3600, so this might be worth doing if you decide to choose an annuity eventually. Also have a look at immediate vesting pensions if you have savings.

It is a bit of a misconception that annuities are a fixed amount for life (at one time perhaps). They can be much more flexible now depending on the product you choose. You can get fixed term ones, index linked ones, and variable rate ones - which are invested and you receive a variable amount depending on how the investments perform, but with a guaranteed minimum income.

It's important to shop around though as providers vary quite considerably on the returns they offer - it's not a standard amount. I rarely think it's worth paying for a financial adviser in most circumstances, but in the case of buying an annuity it's to be recommended. Once you have bought an annuity you can't change your mind. (I am not a financial adviser - so always do your own research).

You mention downsizing. This might well be a suitable option depending on your circumstances. I would suggest when the time comes you also do consider equity release schemes, if you don't want to move. They are now very well regulated, and many mainstream lenders offer them with attractive safeguards and flexible terms. I know many people are very wary of them because of the past scandals, but the products on offer now are very much improved and worth investigating. It might not be suitable at all for your situation, but I would say keep an open mind until you have found out what is available.