Pensioners brace themselves for lower incomes
Annuities, which provide an income for life in retirement, are at their lowest rates for many years and will continue to fall, experts warn.
The latest quarterly MGM Advantage annuity index reveals a small decline in standard annuity rates (0.18%) between March and June, and a more significant 3.5% fall for enhanced annuities available to those with medical conditions.
The Annuity Bureau's figures show that over three months to August, the average level annuity bought by a 65-year-old male with £50,000 has fallen by 3%.
More cuts to come
But Billy Burrows, director of the Better Retirement Group, believes they're likely to fall more dramatically looking ahead, because they're linked to UK government bond (gilt) yields, which have dropped to their lowest level for many years as nervous investors snap gilts up in the face of the eurozone and US debt problems.
"It can only be a matter of time before insurance companies start cutting their annuity rates," he says.
That development in the annuities market comes on top of the long-term trend for people to live longer: 20-year-olds are three times more likely than their grandparents and roughly twice as likely as their parents to live to 100, according to the Office of National Statistics. That means annuities have to last them longer.
MGM Advantage says that between June 2009 and December 2010 increased longevity contributed towards conventional annuity rates on average falling by 7.9%, and that "a long-term decline in returns can be expected".
Struggling to maintain income
The combination of falling annuity rates and rising inflation, which the Bank of England says could hit 5% by the end of the year, means pensioners are increasingly struggling to maintain a 'real' income. The average conventional annuity rate in June 2011 was just over 1% ahead of the retail prices index, according to MGM Advantage data; 18 months earlier it was over 3% ahead of RPI.
These are alarming trends - and complicated further for people just about to retire now by the recent plunge in stockmarkets. As Billy Burrows explains, while you wait for the market to rebound and boost the value of your pension pot, rates could slip further.
"Those intending to purchase an annuity in the near future may be advised to do so before insurance companies cut annuity rates again," he adds.
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.