Annuities: retirement income falls by 30%
An unintended effect of the QE scheme – that saw the Bank of England issue £375 billion worth of new cash to purchase government bonds and boos the economy – is that pensioners' retirement income has been decimated, a report has indicated.
AXA Life Europe says annuity rates fell by a third since March 2009, to hit the record lows in the second quarter of 2013.
Simon Smallcombe of Axa's UK arm said: "QE has been blamed as one of the main factors in pushing down annuity rates and when you look at the timing of the Bank of England's programme and look at the annuity rates over that time, there is a clear trend of decreasing rates.
Annuity rates are mainly driven by the interest paid by the Treasury on government bonds, also known as gilts. Quantitative easing boosted the price of bonds, which, in turn, drove down the interest paid on them, known as the yield.
Axa said this means pension saver who converted a £100,000 pension pot into an annuity would have obtained an annual income of £5,040 in the second quarter of 2009. But this fell to £3,580 in the second quarter of 2013 – a drop of 29%. Over 25 years, the difference between the annual incomes reaches £36,500.
At the peak of annuity rates in the second quarter if 2007, the same pensioner would have realised £5,1010 from his pension pot.
Axa's Smallcombe added: "The most useful step people between five and 10 years from retirement can take is to seek advice as early as possible. This allows the adviser to research all options available, such as unit-linked guarantees for people who want to protect their pension pot from falling annuity rates and negative market movements but stay invested to capture any growth at the same time.
"The ability to secure a guaranteed future retirement income and stay invested in the markets with the potential for growth can be a real alternative and does not rule out any option at the chosen retirement date in the future. Unlike annuities, unit-linked guarantees offer flexibility as policy holders can access and move their money if they choose to do so."
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
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.
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.