Annuity rates have fallen by 20% over the past three years, as a result of government action to keep interest rates low and inflation under control.
In August 2009, a healthy 65-year-old man with a £100,000 pension pot would have got an annuity of £6,410, according to a report by annuity experts MGM Advantage. But now that same man would receive an average annuity income of just £5,158 - £1,252 less than if he had bought it three years earlier.
Aston Goodey, distribution and marketing director at MGM Advantage, warns that "annuity prices are in free fall", as rates for a standard annuity have fallen by 7% in just the three months from June to September.
An annuity is an insurance policy you buy upon retirement with your pension pot, and it pays you a set income for the rest of your life. So, falling rates mean poorer pensioners.
Annuity rates are based on the returns of 15-year government bonds, known as gilts, which have fallen following the Bank of England’s quantitative easing programme, which involved the purchase of gilts in an effort to inject money into the economy and control inflation.
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So what can you do?
With annuity rates now lower than ever it is very important that you compare rates before you buy one.
Many soon-to-be retirees simply buy an annuity from the company that holds their pension. But shopping around is essential as the difference between the best and worst rate could be as much as 50%, according to Rob Tinsley, spokesperson for Aspire to Retire.
The decision is also irreversible so it’s vital that you get the best possible annuity rate available to you. Otherwise your golden years may end up tarnished.
Quantitative easing
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Inflation
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).
Gilts
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.
Annuity
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.
