Perfect storm is another blow for annuity rates

The last 18 months, as readers will know, have seen the introduction of a brave new world of pension freedoms, where retirees can opt to manage their retirement funds in a way that fits better with their changing financial needs as they get older.

That's a great boon for many. But it's widely recognised that not everyone wants - or indeed can afford - financial uncertainty in retirement. A secure income for life, even if only a modest one, is a valuable thing to ensure basic bills and expenses are covered.

Indeed, one popular school of thought among professional advisers is that a combination of secure income - most likely an annuity or final salary pension alongside the state pension - supplemented with payouts from an investment-based pension fund is likely to appeal to many people retiring now.

But prospects for a securely funded retirement have never looked worse.


Tom Selby, senior analyst at AJ Bell, describes the circumstances shaping the dismal outlook for both annuities and final salary pensions as a 'perfect storm of economic uncertainty, monetary policy shifts and rising life expectancy'.

Most recently, the Bank of England (BoE) has cut the base rate by 0.25 per cent and introduced a further £70 billion of quantitative easing, with a view to staving off an economic downturn in the aftermath of the EU referendum.

That move may or may not benefit the UK economy, but it certainly hasn't done those about to retire any favours: when the government buys bonds, gilt yields fall, and it's gilt yields that shape annuity rates.

Consequently, 10-year gilt yields have dropped to new lows, and annuity rates - which were already feeling the pain of Brexit uncertainty as investors flocked to gilts as a safe haven, forcing yields lower - have taken yet another nasty hit as a result.

Gary Smith of Tilney Bestinvest reports a 5.4 per cent fall in the value of a quote he obtained for a client over the month from early July to early August.

This move, however, is just the latest slash in the 'death by a thousand cuts' that has afflicted annuities over the past eight years or so since the financial crisis.


To put that into context, if a 65-year-old man - let's call him Frank - had retired and used £10,000 to buy an annuity in mid 2008, he'd have received a rate of around 7.6 per cent; now he'd get 4.7 per cent.

Put another way, if Frank had decided in June 2008 that a secure annuity income of £1,000 a month would ensure he didn't have to worry about the essentials, he would have needed a pension fund of £158,000 to buy that income stream.

If he made that decision in August 2016, he would need a fund of just over £255,000.

In fact, although the spotlight in the aftermath of the latest rate cut has been on the impact on savers, it's those about to buy an annuity who, arguably, have been much worse hit.

Savers were already receiving next to nothing, but the impact of falling gilt yields will inevitably have knocked a few hundred quid a year off the lifetime income of those who have no option but to buy their annuity now.

There's little joy either for those in final salary schemes, who thought they could look forward to a securely funded retirement. Their fortunes too are dependent on gilt yields, which are used to price scheme liabilities.

Some employers may have no option but to change the benefits due from the schemes in order to reduce ballooning deficits.


What, if anything, can be done? We cannot offer much cheer to final salary scheme members, though it would make sense to save any spare cash into an Isa that will provide a tax-free supplementary income when needed.

For some annuitants, there may be the option of simply waiting to see if the BoE eventually starts tightening monetary policy, though it's hard to imagine how that will happen in the current low-growth, low-inflation world.

Smith doesn't mince his words: 'With little expectation of an increase in interest rates in the short term, the future for annuities seems very gloomy indeed.'

However, pension freedoms do at least mean annuities are not the only option. It may make sense to buy a reduced lifetime income and invest more of your pension fund to produce an equity-generated income.

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