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Interest rates & annuities in 2022

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This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.

Have you wondered about the best way to fund your future retirement? Broadly speaking, a pension pot is commonly used in one of two ways to provide an income. The first is to go into drawdown (i.e. make withdrawals, a bit like using a bank account, whilst keeping the rest of the funds invested). The second is to use the funds to buy an annuity; a financial product which provides a guaranteed lifetime income in retirement.

This latter option can be very attractive – especially for those seeking financial stability and predictability in retirement. Yet the annuity market is not static. Products can vary in their quality and level of income, particularly due to interest rates. With rates currently at an historic low (yet recently increased, in December 2021), how might annuities be affected? Are they a viable option for people looking to retire in 2022?

Below, our team at Castlegate (financial planners in Lincoln) address these questions. We hope you find this content helpful. If you want to discuss your own financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:

01476 855 585

Why interest rates matter to annuities

Annuities are typically offered by insurance companies. To afford the payouts to customers, and remain profitable, these businesses also typically invest the money they receive (from annuity buyers) into “lower risk” assets, like UK government bonds (gilts). These kinds of assets, whilst lower risk (important to protect insurers’ balance sheets), are highly influenced by interest rates.

Generally speaking, the lower the base rate set by the Bank of England (BoE), the lower the returns offered by gilts and other bonds. This is because the BoE essentially sets the cost at which the UK government can borrow money. If interest rates are high, it costs the government more to borrow. Moreover, investors who buy new bonds can access higher returns from the interest rate payments.

The opposite is also true. If interest rates are low, the government can borrow more cheaply but bond investors cannot make the same high returns by lending their money. Similarly, insurance companies investing in bonds cannot generate the same profits from their bond investments. As such, this typically results in annuity providers passing on these costs to their customers – i.e. by offering annuities with lower payouts.

Annuities & interest rates in 2022

You may have noticed that your easy-access savings account likely offers a low interest rate. It is very difficult to achieve over 1% these days. The reason is mainly down to the base rate. The BoE has set its “base” interest rate at historic lows for some time now. In 1998, for instance, this stood at 7.50%. Your savings account likely had a much better interest rate at this time, and buying an annuity would have been very attractive. Yet in 2020, this had lowered to 0.25% and then went even further down, to 0.10%. Banks largely follow the base rate when setting their own rates, meaning interest rates on most regular savings accounts today are quite poor.

As mentioned, low interest rates tend to compress the incomes offered by annuity products on the market. Yet there is evidence to suggest that this might change in 2022. In December 2021, the BoE raised its rate back up to 0.25% in an effort to counter rising inflation (which now stands at its highest in ten years). If inflation persists and rises further in the coming months, the BoE will likely face pressure to raise the base rate further. Should this happen, it could encourage a return of more competitive annuity products.

Risks to consider

With this said, it is important not to delay your retirement planning – or build it primarily upon assumptions about what will happen with interest rates and inflation. Also, bear in mind that rising interest rates is not necessarily good news. Whilst it may usher better interest rates on savings and better annuity products, it also means higher mortgage payments for those with variable-rate mortgages. Moreover, rising inflation means that the cost of goods and services, overall, goes up – meaning that each £1 of your income cannot stretch as far as before.

Retirement planning involves taking a wide range of risk factors into account when building a strategy to achieve your financial goals. Here, it can help to discuss things with your financial planner, who can help ensure that you maintain a healthy, sustainable income in retirement. Whether or not you buy an annuity, for instance, will partly depend on the annuity market and also your desired retirement lifestyle. In some cases, it makes sense to use pension funds primarily – even solely – for drawdown. Others might buy an annuity to provide income for their essential retirement costs, and use drawdown to cover their discretionary spending.

Conclusion & invitation

If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:

01476 855 585