What are guaranteed annuity rates and how do they work?

If you have older pension contracts or legacy pension policies from the 1980s or 1990s, you may have come across the term, but what are guaranteed annuity rates (GAR), and why do they matter?

But do you understand how this valuable pension income feature affects your retirement planning? Ignoring a guaranteed annuity rate could be a costly mistake, potentially reducing your income in retirement by thousands of pounds.

What are guaranteed annuity rates (GAR)?

At retirement, many people with defined contribution pensions use their pension funds to buy an annuity. It is a product that pays a guaranteed income for life.

A guaranteed annuity rate (GAR) is a special feature in some older pension policies. The GAR allows you to convert your pension pot into an income at a fixed, pre-agreed rate when you retire.

The pension provider set the GAR in the terms and conditions of your policy when you started it, and they cannot change it.

Guaranteed annuity rates, how do they work?

To understand what are guaranteed annuity rates, you need to know that pensions with a GAR guarantee a certain income level for every £1,000 of pension savings.

Rates are usually more generous than present-day standard annuity rates, making GARs extremely valuable.

GARs depend on interest rates from decades ago, when they were much higher. And they do not change in line with today's market.

For example, if you have a pension fund of £100,000 that has a GAR of 10%. This will give you an income of £10,000 a year for life. On the other hand, an annuity at today's rates may only offer £5,000 - £6,000 a year, so it makes quite a difference.

Is it a good thing to have a guaranteed annuity rate?

Over the years, standard annuity rates have fallen. Thus making policies with a GAR seem very attractive. However, before deciding, it's essential to understand what are guaranteed annuity rates, how they work, and any restrictions they might come with.

Some providers design policies that do not offer benefits for spouses or family, and they may also prevent you from passing funds to loved ones. There could be restrictions, such as a single life level basis. Meaning that the provider pays the annuity to one person only and does not increase it once payments begin.

Or, there could be restrictions regarding the guaranteed payout period. Instead of an income for life, your policy might limit income payments to a fixed number of years.

You must understand your contract because GAR policies vary widely. It may be wise to consult a financial advisor who can fully explain the terms to you.

How do I know if I have a guaranteed annuity rate (GAR)?

Finding out if you have a GAR is not always easy. If unsure, speak directly with your pension provider to get started. Royal London, Prudential, Reassure, Aviva, Aegon, Phoenix Life and Sun Life Financial of Canada are some of the more common GAR providers.

Your pension provider must tell you about your guaranteed annuity rate as you approach retirement. They must do this before you start accessing your funds, or you make a request to move your pension elsewhere.

Typically, the provider will send you a retirement pack usually from the age of 50. It should include information about dates and the GAR available.

Ensure you don't miss out

In the past, some providers have tried to encourage clients with old GAR policies to switch to newer pension schemes. These seem to appear more attractive on the surface but do not include guaranteed rates. Remember, you will lose all the guaranteed benefits if you transfer your funds.

If you have a GAR, on your pension scheme. There could be restrictions on when you can implement it.

Pay special attention to dates. Some schemes require you to purchase the annuity on your 60th or 65th birthday, and they will reject any other day.

Others might offer a more generous timeframe of a few months from your chosen retirement date. Or perhaps stipulate a minimum age. You need to be aware of the restrictions in plenty of time prior to making a decision to avoid missing out.

Even if you have a GAR, checking elsewhere for better annuity rates could be worthwhile. However, in most cases, a GAR will be almost impossible to beat.

New pension freedoms and guaranteed annuity rates

The introduction of pension freedoms has given people more choices from age 55 (rising to age 57 in 2028). Allowing them to cash in their pension pot or reinvest it instead of being obligated to purchase an annuity.

However, because of the GAR, you could forego a substantial amount of money by cashing it in instead of taking the guaranteed annuity. This makes it crucial to ask what are guaranteed annuity rates, and whether using one fits your retirement goals.

This highlights the importance of seeking expert financial advice when approaching retirement.

Can I transfer my guaranteed annuity rate pension fund?

Transferring GAR pension funds to a flexible access pension is possible. You may feel flexible access suits your personal situation and retirement goals.

However, if your fund exceeds £30,000, you will require financial advice from a regulated advisor to comply with current regulations.

Also, if you are in ill health, a pension with a GAR may not be suitable. You may want to take the whole fund as a lump sum, depending on your situation. Or you may qualify for a medically enhanced annuity, which takes into account certain serious medical conditions.

Many chose to transfer to flexible access drawdown schemes. These schemes allow them to withdraw money from their pension pot as and when they please. It is a popular alternative to the restrictive income options of GAR schemes.

Should I stick with my guaranteed annuity rate or not?

If you're wondering what are guaranteed annuity rates worth in practice, consider that a GAR can be worth thousands of pounds in extra income over your lifetime.  The GAR will usually exceed whatever income you could get elsewhere.

It could be the right option if you want a secure, guaranteed income. And, you prefer financial certainty and stability. It's safe and predictable and ideal for risk-averse retirees.

Some drawbacks are specific retirement age restrictions, such as age 60 or 65, and retiring earlier or later could result in losing the GAR.

A GAR is a lot less flexible compared to pension drawdown. And unless specially built in, there may be no options regarding spouses' benefits and/or inflation protection.

You will lose the GAR if you transfer the pension to another provider.

Get expert advice

Most people find it difficult to understand and calculate GAR benefits.

Before making any decisions about what is best, consider consulting a professional financial advisor. They can help you understand what are guaranteed annuity rates, and whether sticking with one aligns with your financial goals.

Don't transfer out of a pension with a GAR without getting financial advice. If you do so, the value lost could be significant.

Let Regulated Advice match you with a financial advisor for expert advice.