Annuity Rate Calculations

Annuity rates are based on a simple enough formula

Annuity payments may stay the same throughout the years of payment or they may have automatic annual increases built in. These annual  increases may be at a fixed rate, e.g. 3% or 5% per year, or they may vary in line with the Retail Price Index (RPI). Annuity payments can also cater for dependants, for example, with a joint life annuity. But how do annuity rates work? How are they calculated? What factors are involved?

The value of the annuity payments are dependent on two factors, the size of the pension fund and the annuity rate offered by the insurance company (the annuity provider) selling the annuity. The annuity rate is basically the factor used to convert the accumulated pension fund into pension income. For example:

Value of pension fund x annuity rate = annuity income

The value of the pension fund is a simple enough factor, but the annuity rate is not. Annuity rates are calculated by actuaries using numerous factors: mortality, interest rates, age, gender, lifestyle issues and health. Nowadays you can add address to this (see postcode annuities) and your occupation whilst in employment, leading to more bespoke annuity rates because of the various factors.

How annuity rates vary

In general terms, annuity rates are higher the older you are because future life expectancy is less. In the same way men get higher annuity rates offered to them than women of the same age due to men having lower life expectancy.

It’s what’s considered beyond age and gender that complicates matters. There are a number of other factors can make quite a difference to an annuity rate. The rate will be higher, resulting in an increased level of income:

if you buy your annuity when interest rates and gilt yields are in your favour;

if you suffer from ill health, and the more severe the illness, the higher the annuity rate;

if you smoke on a regular basis;

if you live in a more deprived area;

if you previously worked in a more hazardous occupation;

if you’re overweight.

The first factor is extremely important, but it’s all to do with timing, which you might not have any control over. You should consider the possible impact of the other factors, as each one can have an individual effect on the annuity rate you might receive because each one reduces your life expectancy.

More importantly, the factors can have a cumulative effect on your life expectancy, so the more of them that apply to you the higher the annuity rate you receive. That’s why it’s important to disclose full details of your personal circumstances.

If each factor meant a 10% increase to your annuity rate (which is not the case, just an example), and having four factors effect you, then your annuity rates would be increased by 4 times 10%, or 40%, whereas for just one factor it would be 10%.

If you’re unfortunate, for example, to have quite severe ill health, smoke, be overweight, and previously been a miner, you should end up with a pretty high annuity rate, especially compared to someone fit and healthy, of average build, non-smoking, and living in the home counties.

Factors that can reduce annuity rates

In addition to the above the annuity type you select has it’s own annuity rate attached to it (for example, a with profits annuity), and the annuity options you select will also effect the rate. The options, such as a guarantee period or joint life, will actually reduce the intial income that is payable.

Also, if you select increasing annuity payments, as opposed to level throughout, this will also reduce the initial income payable.

You can call us free on 0800 077 35100800 169 1256; or you can request a free annuity quote online.