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.

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 (at least until pension freedoms happened).

The problem with annuities is the rates have been poor in the past although have recently risen alongside the Bank of England's base rate.

The 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 £5,000 a year if you get a rate of 5%.

Some annuity rates are currently higher than this, so you could get more than £6,000 a year.

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 4%.

Back in the 1980s, annuity rates were much higher, which is what makes old guaranteed annuity rates so exciting.

Why is it good to have a guaranteed annuity rate?

A guaranteed annuity rate is a feature of some pension schemes, guaranteeing you can buy an annuity at a particular rate.

Common rates offered are around 9% to 11% (occasionally higher), so they are around double 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 £5,000 a year – a difference of £120,000 over a 20-year retirement.

The kinds of pensions that most often include a GAR are with-profits pensions taken out before 1988. They are sometimes known as retirement annuity contracts or Section 226 policies.

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 policy paperwork carefully, or better still, ask a financial adviser to do it for you.

Often, the term ‘guaranteed annuity rates’ will not be used, so look for language like ‘benefits’, ‘preferential’ or ‘guarantee.’ It’s also a good idea to ask the provider straight out.

Sadly, some providers won’t bother reminding you about your GAR – for the simple reason that it will cost them a lot.

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

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 the annuity on your 60th birthday.

Others might have a more generous window of several months or just a minimum age – but whatever the restriction, make sure you know about it beforehand.

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.

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 independent financial advice when approaching retirement.