Where next for annuity rates?
Annuity rates play an enormous part in determining just how much income you can generate from your pension. To help you time your purchase just right, we've asked a panel of annuity experts to share their views on the current state of the annuity market and where it's expected to go in the coming years.
Q. What has happened to annuity rates so far in 2013?
Dr Ros Altmann, independent pensions expert: "Annuity rates fell sharply in the second half of 2012 but have picked up a little over the past few months, from the ludicrous lows they reached at the turn of 2013. Anyone who bought an annuity at the low will have lost out on significant amounts of income for the rest of their life, which they can never make back up again. Those reaching retirement now still need to consider whether this is the right time to lock into a lifetime annuity, as rates are still low in historical terms. They may prefer to wait and keep their money invested for longer, especially if they have other sources of pension as well."
Andrew Tully, pensions technical director, MGM Advantage: "Annuity rates have been edging up slightly over the past couple of months but they are still bumping along the bottom, well down on where they were even a couple of years ago. Annuity rates are now around 5.7% but in March 2009 – when the first round of quantitative easing (QE) took place - they were approximately 6.9%. There are a whole host of drivers for annuity rates but QE, and its impact on gilt yields, is one of the factors which have pushed rates down over the last few years."
Tom McPhail, head of pensions research, Hargreaves Lansdown: "Annuities have been on a fairly relentless downward trend for the past five years, followed by a pronounced rebound since the beginning of this year – up around 10%. Nevertheless, they are still not far off their all-time low. A key driver has been quantitative easing but there is more to it than that. Rates have been driven downwards by improving life expectancy, increasing use of underwriting and by the abolition of gender pricing."
Q. How do you expect rates to change in the next year or two?
Dr Ros Altmann, pensions expert: "The outlook for the next couple of years is clouded by the actions of the Bank of England and trends in the fiscal deficit, as well as the trend of interest rates and inflation both here and overseas. It seems much more likely that interest rates will rise, rather than fall, in the next few years and as an annuity is meant to last for maybe 20 years or so, locking into low rates that have been artificially held down by the Bank of England may not be the best course of action. Also, if you are in good health, buying an annuity now may mean you will lose the chance of much better income later - but of course, if interest rates stay low or fall further (even though that is not the most likely scenario) it could be that annuity rates will not improve."
Andrew Tully, pensions technical director, MGM Advantage: "The continuing increase in longevity means people are living longer and basic arithmetic means their pension pot needs to stretch over more years and so the yearly income is lower. Forthcoming EU changes, called Solvency II, mean annuity providers will need to hold greater capital reserves which will also push rates downwards. The growth in the enhanced annuity market is great for those who qualify for a greater income due to their health or lifestyle. However it takes more 'ill' people out of the main annuity pool and means those healthy people left behind will get a lower income (as on average they will live longer). Gilt yields are near historic lows and it will take time for them to recover, but I do expect gilt yields to increase, which will have a positive knock-on effect on annuity rates. However, at least some of any positive benefit over the next couple of years will be offset by the other drivers. So at best we are likely to see a small increase in rates."
Billy Burrows, head of business development at Annuity Line: "Mark Carney, the governor of the Bank of England, recently announced the ‘forward guidance' policy, whereby the bank will not consider raising interest rates until the unemployment rate falls under 7%. However if the inflation rate increases above 2.5% in the medium term the bank could increase rates to combat the inflation threat. So what does this mean for annuity rates? If one of the effects of forward guidance is to dampen down long-term interest rates, then we should not expect significant increases in annuity rates in the near future, unless there are some surprises in store, for example higher inflation."
Q. What does this mean for people approaching retirement?
Andrew Tully, pensions technical director, MGM Advantage: "While it may be tempting to delay your annuity purchase in the hope rates will get better, the decision is just as likely to backfire, as it's almost impossible to second-guess annuity rate movements. If people do decide an annuity is the best solution for them they should shop around for the best deal, which can boost income substantially. And it's crucial to reveal any health or lifestyle conditions as this will give you more income from an enhanced annuity – we believe around seven in 10 of those at retirement could qualify for an enhanced annuity and therefore receive a higher income. Taken together, shopping around and taking health into account could mean your income is 40% more every year compared to the original offer."
Tom McPhail, head of pensions research, Hargreaves Lansdown: "If you want the low risk option then buy an annuity as this eliminates any market risk, however absolute security in the form of an inflation-linked annuity does not come cheap.
"If you want a balanced approach, my preferred option is to go for a combination of an annuity on a level single life basis, combined with a drawdown plan invested in equities and paying income at the level of the dividend income (ie around 3.5% to 4%). This combination approach balances off your conflicting risks and gives you some security, some flexibility, some inflation proofing and some death benefits."
Billy Burrows, head of business development at Annuity Line: "For anybody considering purchasing an annuity, it may become prudent to take as much time as is needed in order to decide what is the right option, but once a decision has been made it might make sense to act straightaway as those who defer their annuity purchase in the hope of getting a higher income are often disappointed."
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.
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).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
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.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).