Guaranteed annuity rates: what are they & how do they work?

Do you have a guaranteed annuity rate (GAR), or know what it is?

Plenty of people may have lost out on their guaranteed annuity rate, but this can be a costly mistake.

What is a guaranteed annuity rate?

First, let's explain what an annuity rate is. As you may already know, an annuity is a regular income paid to you for life or for a set time period. 

The amount is always predictable, and the money can never run out.

This element of certainty has made annuities one of the most popular retirement options for years.

The problem with annuities is that rates have been poor in the past, but they have improved significantly along with the increase in the Bank of England's base rate in recent years.

Your annuity rate determines how much annual income you receive, depending on various factors, including your age, state of health and even where you live, but most of all on the market itself.

Let’s suppose you have a pension pot of £133,333 and take your 25% tax-free lump sum.

This leaves you with £100,000, with which you could buy an annuity.

Assuming you retire at 65 in good health and want a no-frills annuity, you can get one that pays around £7,500 a year if you secure a rate of 7.5%.

Some annuity rates are even higher than this, but they fluctuate depending on Bank Rate and the economy, so you may not get such a good deal when you come to retire.

If you want extra features, such as a joint life annuity (to cover your spouse, too) or one that rises with inflation, the rate would be lower – you might be looking at closer to 5%, for example.

Back in the 1980s, annuity rates tended to be much higher than today, which is what makes the prospect of having a guaranteed annuity rate so attractive, as these are based on the rates at the time.

Why is it good to have a guaranteed annuity rate?

A guaranteed annuity rate was a feature of some pension schemes from the 1980s and 1990s, guaranteeing you could buy an annuity at a particular rate.

Common rates offered tend to be around 9% to 11% (occasionally higher), so they are often a lot higher than the best rate most people can achieve on the open market.

In the above example, a GAR of 11% would give you £11,000 a year instead of around £7,500 a year – a difference of £70,000 over a 20-year retirement before tax.

The kinds of pensions that most often include a GAR are with-profits pensions taken out before 1988, although these pensions were sold well into the 1990s.

They are sometimes known as retirement annuity contracts or Section 226 policies. As well as personal pensions, some workplace pensions may have a GAR.

How can I find out if I have a guaranteed annuity rate?

It's not always easy to find out if you have a guaranteed annuity rate. You need to go through your pension policy paperwork carefully, or better still, ask a financial adviser to do it for you.

Often, the term ‘guaranteed annuity rates’ might not be used, so look for language such as ‘benefits,’ ‘preferential,’ or ‘guarantee.’ It’s also a good idea to ask the provider directly.

Unfortunately, some providers won’t go out of their way to remind you about your GAR – for the simple reason that it will cost them more.

They may even send you letters encouraging you to move to their newer, superficially more attractive but non-GAR pension scheme.

However, by law, if you have a GAR, your pension provider must make you aware of the fact as you get closer to retirement and begin taking money from it or if you decide to move it elsewhere.

In fact, if you try to move your pension elsewhere and it includes a GAR, you’re obliged to use regulated financial advice before doing so if your pension pot is over £30,000.

Make sure you don’t miss out

Even if you have a GAR on your pension scheme, there may be restrictions on when you can exercise it.

For instance, some schemes make it a condition you must buy a guaranteed annuity on your chosen retirement date or you will lose the rate.

Others might have a more generous window of several months around this date or just a minimum age – but whatever the restriction, make sure you are aware of it in good time. 

There may also be other restrictions on the type of annuity you can buy. For example, if you wish to include a continuing income for a dependant, such as your husband or wife, the rate could be lower, or the guarantee may not apply. 

Some providers will only offer the GAR if you use your entire pension pot to buy your annuity, so be very clear what the rules are around your GAR when making decisions around your entitlement to take 25% tax-free cash.

Don’t forget to shop around for the best annuity rate, even if you have a GAR.

Is a guaranteed annuity rate always better?

In most cases, a GAR will beat current annuity rates hands-down.

However, if you are in poor health, which could reduce your life expectancy, you may qualify for an enhanced annuity, in which case you may achieve a better rate than with a GAR

Guaranteed annuity rates and pension freedoms

Pension freedoms have made it possible to cash in your pension pot or reinvest it instead of buying an annuity.

Before you make any decisions in this area, double-check to see if your pension comes with a GAR.

If it does, you could lose a life-changing amount of money by cashing it in rather than taking the guaranteed annuity.

This is yet another reason to seek financial advice when approaching retirement.

Need financial advice?

If you need help planning your retirement or figuring out how to spend your pension to ensure you don’t risk running out of money, Unbiased can help.

Unbiased can quickly connect you with a qualified financial adviser.