What Is An Annuity, And Why Do They Matter?
An annuity is generally a fixed sum of money paid to someone each year, often defined as payable for the rest of their life. These have typically been purchased from insurance companies upon retirement. A typical annuity quote would be something like, in exchange for every £15 (~US$20.34) of up front cost, I will pay you £1 (~US$1.36) of income each year. These are an important part of the pensions landscape. This is particularly true for personal pensions or defined contribution pensions[1]’, which now make up the majority of pension arrangements in the U.K., where individuals have their own distinct pension “pot” or allocation.
Hence, the cost of an annuity can be conceptualized as the cost of retirement, since it forms the link between the pot of money being saved up, and the guaranteed income that can be realized from that.
This “cost of retirement” has been vastly increasing in recent years. As the examples at this link illustrate[2], the income paid in exchange for a £100,000 (~US$135,522) fund for a 65-year-old has decreased from just over £7,000 (~US$9,486) in December 2006 to around £5,100 (~US$6,911) in December 2021. This example is for a simple single-life pension (no dependents pension is paid) with no guarantee period or other complexities.
Put another way, if you want a set income payable to you in retirement as an annuity, you now have to[3] save ~25% more than someone retiring at the same age 15 years ago.
Moreover, £5,100 (~US$6,911) is the pension payable that does not increase over time. If we want our annuity to increase by 3% per year, our £100,000 (~US$135,522) will currently only pay us a starting annual amount of
