Equity Release Versus Pension Annuity: An Overview
When planning for retirement, there are several options available for generating income in later life. Two popular options are equity release and pension annuities. Both of these options can provide a steady income stream, but they work in different ways and have their own pros and cons.
Page last updated – 16th February 2023
Equity release is a financial product that allows homeowners to access the equity in their homes while still living in them. It can be a way to supplement retirement income or provide a lump sum for other purposes. Here are some of the pros and cons of equity release:
- No need to move: With equity release, homeowners can stay in their homes and continue to live there as long as they wish.
- Flexibility: Equity release can be tailored to meet the individual needs of the homeowner. For example, the homeowner can choose to release a lump sum or regular income, or a combination of both.
- No repayments required: With some equity release products, the homeowner does not need to make any repayments during their lifetime. Instead, the interest is added to the amount owed and repaid when the property is sold.
- High interest rates: Equity release products typically have higher interest rates than other types of borrowing. This means that the amount owed can quickly add up, potentially leaving little to no equity in the property to be inherited by the homeowner’s heirs.
- Effect on benefits: Equity release can affect eligibility for means-tested benefits, such as Pension Credit or Council Tax Reduction. It is important to seek advice to understand how equity release could affect your benefits.
- Reduced inheritance: Equity release can reduce the amount of inheritance that is left to heirs. This can be a concern for homeowners who wish to leave an inheritance to their loved ones.
According to the Equity Release Council,
Total lending for 2022 reached £6.2bn, a 29% increase from £4.8bn in 2021 and a new annual record for the market. It means the equity release market has doubled in size over the last five years, having seen £3.06bn of annual lending in 2017.
A pension annuity is an insurance product that provides a guaranteed income stream in exchange for a lump sum payment. It can be purchased using a portion of a pension pot, and is designed to provide a steady income for the rest of the policyholder’s life. Here are some of the pros and cons of pension annuities:
- Guaranteed income: With a pension annuity, the policyholder is guaranteed a regular income for the rest of their life. This can provide peace of mind and financial security in retirement.
- No need to worry about investments: Pension annuities do not require the policyholder to manage investments or take on investment risk. Instead, the policyholder can simply sit back and enjoy their retirement income.
- Potential for enhanced rates: Some pension annuity providers offer enhanced rates for individuals with health or lifestyle conditions that could reduce their life expectancy. This can provide a higher income for those who may have a shorter life expectancy.
- Fixed income: Once the pension annuity is purchased, the income stream is fixed and cannot be adjusted. This means that the policyholder may be locked into a lower income than they could achieve through other means.
- No flexibility: Pension annuities provide little flexibility in terms of access to the lump sum or the income stream. Once the annuity is purchased, the policyholder cannot make changes to the arrangement.
- No inheritance: With most pension annuities, there is no lump sum or residual value left over after the policyholder’s death. This means that any unused portion of the annuity cannot be passed on to heirs or beneficiaries.
Data in the 2022 Market Report published by the Financial Conduct Authority (FCA) in 2022 found that:
Annuity sales in the UK increased by 13% in 2021/22, rising from 60,383 in 2020/21 to 68,514 in 2021/22. This increase in annuity sales may be due to a variety of factors, such as changes in market conditions, regulatory changes, or shifts in customer preferences.
In addition, the overall value of money being withdrawn from pension pots rose to £45,638m in 2021/22, an increase of 22% from the previous year’s figure of £37,432m. This significant increase in the overall value of money being withdrawn from pension pots suggests that more individuals are taking advantage of the flexibility offered by pension freedoms introduced in 2015, which allow individuals greater control over how they access their pension savings.
Pros and Cons Compared
When considering equity release versus pension annuities, it’s important to understand how they compare in terms of the key factors that matter to retirees. Here’s a side-by-side comparison of the pros and cons of each option:
· No need to move
· Guaranteed income
· No investment management is needed
· Potential for enhanced rates
· High interest rates
· Effect on benefits
· Reduced inheritance
· Fixed income
· No flexibility
· No inheritance
Overall, both equity release and pension annuities can provide a reliable source of retirement income, but they have different trade-offs. Equity release provides more flexibility and allows homeowners to stay in their homes, but has higher costs and could reduce inheritance. Pension annuities provide a guaranteed income stream and no investment risk, but can be inflexible and provide no inheritance.
When considering whether to use equity release or pension annuities, it’s important to think about your own personal circumstances and goals. Do you want to stay in your home? Do you value flexibility over guaranteed income? Are you concerned about leaving an inheritance?
Working with a financial adviser can help you make the right decision and avoid costly mistakes. Additionally, using a combination of equity release and pension annuities may be a suitable solution to get the best of both worlds.
Combining equity release and pension annuities
This can provide retirees with the benefits of both options, while mitigating some of their respective drawbacks.
One potential strategy is to use equity release to access a lump sum that can be used to purchase a pension annuity. This could provide a guaranteed income stream while preserving some home equity. Alternatively, some retirees may prefer to use a portion of their pension savings to purchase an annuity, while using equity release to supplement their income or pay for expenses.
By using both options together, retirees can benefit from the flexibility and potential for inheritance with equity release, as well as the guaranteed income and no investment risk with pension annuities.
There are also other potential benefits to combining equity release and pension annuities. For example, using equity release to pay off an outstanding mortgage or other debts could reduce financial stress and improve overall retirement security. Additionally, some equity release providers offer discounts or incentives for purchasing pension annuities, which could help offset some of the costs of both options.
Here’s a hypothetical example of how the two products could be used together
Meet John, a 65-year-old retiree who owns a £500,000 home, has no mortgage and has a pension income of £10,000 per year. John wants to maintain his current standard of living in retirement, but also wants to release some equity from his home to provide additional income.
After speaking with a financial adviser, John decides to take out a lifetime mortgage with a lump sum of £100,000. The interest rate on the loan is 3.5% per annum, and the loan does not need to be repaid until John either passes away or sells his home. This means that John can remain in his home and use the released equity to supplement his pension income.
However, John is also concerned about the impact of the lifetime mortgage on his entitlement to Pension Credit. After discussing this with his adviser, John decides to use some of the money from the lifetime mortgage to purchase a pension annuity. The annuity will provide him with a fixed income for life, and as it is not means-tested, it will not affect his entitlement to Pension Credit.
John decides to use £50,000 of the lump sum from the lifetime mortgage to purchase the annuity, which will provide him with an additional income of £2,500 per year. This brings John’s total annual income to £12,500, which is enough to maintain his standard of living in retirement.
Overall, John’s plan to use a lifetime mortgage and pension annuity has been successful. He has been able to release some equity from his home to supplement his pension income, while also protecting his entitlement to Pension Credit.
Of course, there are also some potential drawbacks to using both equity release and pension annuities together. For example, if too much home equity is released, it could reduce the inheritance left for heirs. Additionally, purchasing a pension annuity typically requires a significant lump sum upfront, which may not be feasible for all retirees.
Overall, combining equity release and pension annuities can be a good idea for retirees who want to maximize their retirement income and flexibility, while minimizing risks and costs. However, it’s important to work with a financial adviser to develop a personalized retirement income plan that meets your individual needs and goals.
If you would like to find out how much money you might be able to get you can use our free equity release calculator. No personal details are required to use it so you don’t have to worry about anybody calling you.