Market turbulance taking a serious toll on annuities
These are seriously troubling times for people about to retire, as their retirement income faces a double blow.
Data from PricewaterhouseCoopers shows that the combination of turbulent stockmarkets and falling annuity rates mean overall pension incomes for people retiring today could be as much as 30% lower than three years ago.
First, stockmarkets plummeted at the end of July and have failed to recover in any meaningful way, with the FTSE 100 still down by as much as 17% in early October, so pension portfolios - particularly those heavy on shares - have lost a lot of value.
But diving equity markets have also driven up the price of government bonds (known as gilts), as nervous investors look for a safer haven for their investments.
As gilt values rise, their yield - the amount they pay out as a proportion of their value - falls. And that also hits retiring people hard, because annuities (the income for life bought with a pension fund) are priced on gilts (and corporate bonds). Thus, if the yields on gilts fall, so does the income paid by annuities.
The annuity trend over the past three years has been a largely downward one.
For example, according to PwC figures, a £300,000 pension pot now converts into a pension income of just £18,500 a year. Three years ago, when annuity rates were more attractive, it was worth almost £22,500.
But the recent market turbulence caused by the sovereign debt crisis has wreaked particular damage. Over the past three months alone, the income from that £300,000 pension fund has fallen by £1,000 as a consequence of falling gilt yields.
Biggest annuity fall for 20 years
Billy Burrows of the Better Retirement Group reports that August saw the largest fall in annuity rates in a single month since he began keeping records over 20 years ago; he estimates that since July, rates have fallen by an average 9%.
"At present, gilt yields are at their lowest levels since World War II and annuity rates are at an all-time low," Burrows comments.
What's the outlook? In the short term, annuity rates could get even worse before they improve as the government has announced a further £75 billion of quantitative easing, which will push gilt prices up further.
So, unless you have a crystal ball, or alternative sources of income in the meantime, there's little point deferring your annuity, says Burrows.
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.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
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.
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.