Annuity rates fall by 6%
The average annual income for a 65-year-old buying a standard level annuity costing £10,000 fell by 5.7% over the course of 2014, according to the latest Moneyfacts report into annuity trends.
The fourth quarter (Q4) alone saw a drop of 2.8% in average standard annuity rates. A £10,000 pension pot would have bought £521 of annual income in the third quarter, but that fell to £506 in Q4.
Enhanced annuities, which pay higher rates to people with medical conditions that could impact on their life expectancy, have been even harder hit.
The Moneyfacts report finds that on average they are down 6.8% over the year and 3.1% over Q4.
Falling gilt yields have been blamed for the deterioration in rates; the report shows "a record volume of annuity re-pricing activity taking place" in 2014, with all providers making cuts to all types of annuity. Rates are now at their lowest since July 2013.
Those falls have been exacerbated by a drop-off in demand for annuities in anticipation of the new pensions freedoms due to be introduced in April.
"The ability of providers to withstand the downward pressure on annuity rates being exerted by lower gilt yields has been curtailed by the reduced demand for annuities since the 2014 Budget, which shows no sign of abating," says Richard Eagling, head of pensions at Moneyfacts.
With less demand, annuities firms are under less pressure to compete in the open market and are instead concentrating on sales to their own pension fund customers, according to Alan Higham, retirement director at Fidelity.
What is the outlook for the coming year?
Billy Burrows, pensions expert at Key Retirement Solutions, says: "It has not been a good start to 2015, as gilt yields have already fallen and the benchmark 15-year gilt has fallen below the 2% mark in mid-January; consequently all the main annuity providers have reduced their rates."
Burrows predicts an increase in bond yields from the current low levels, which he believes should translate into higher annuity rates. "There is a useful rule of thumb, that every percentage point rise in bond yields will result in annuity rates increasing by about 7%.
"My best guess is that yields will bounce back to the 2.5 or 3% mark during 2015 - so we cannot expect annuity rates to return to the levels seen at the beginning of the year, but we could see a 2 or 3% increase," he adds.
This might mean that for every £100,000 invested, the annuity income should increase by about £150 a year.
"However, those thinking about purchasing an annuity in the first half of 2015 shouldn't hold their breath because any increases will be gradual," cautions Burrows.
This article was written for our sister website Money Observer
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
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.