With the annuity crisis deepening many people are being advised to adopt a flexible approach, such as via self-invested personal pensions (SIPPs) and income drawdown.

Annuity rates continue to slide, piling on the agony for hundreds of thousands of new pensioners. Rates hit new lows this week, as Standard Life cut its annuity rates by 5pc, knocking £250 a year off the income from a £100,000 pension pot. The annuity crisis decimating the pensions of savers when they retire is set to continue for months, perhaps even years. Billy Burrows, an annuity specialist at the Better Retirement Group, said: “I long to stop reporting continued falls in annuity rates, and I hope that moment arrives very soon because annuity rates have again fallen to all-time lows as a consequence of the continued uncertainty and volatility in the financial markets caused by the European debt crisis.”

Annuity rates have been in decline for 20 years, mainly because we are living longer, meaning that insurers have had to guard against paying out over an increasing number of years. But this decline has been accelerated by the financial crisis and, arguably, quantitative easing (QE), which have caused interest rates and gilt yields to fall. At the start of the Nineties, a £100,000 pension fund would have guaranteed an income of £15,640 a year for life. Twenty years on, a 65-year-old man will secure just £5,140 a year. It has not all been bad news. Investors who have been investing in “lifestyle” pension funds will have benefited from rising gilt prices. Lifestyle funds automatically switch people’s pension pots out of equities and into lower-risk gilts as they near retirement.

According to Hargreaves Lansdown, the average lifestyle fund has risen by 51pc since March 2009; over this time annuity rates have fallen by 21pc. “Savers in these funds would therefore have done pretty well on balance out of ballooning gilt prices,” said Laith Khalaf from the company. But that does not disguise the fact that annuity rates are likely to stay depressed for many months to come. Those savers who have yet to make a switch to bond funds will not benefit from gilt price rises, but they will still suffer low rates when they convert their pension pot into an annuity. Mr Khalaf said: “It looks unlikely that interest rates will rise, or quantitative easing will be unwound, any time soon. Indeed, the opposite looks more likely, so yields could fall further in the short term. But when they do eventually rise, lifestyle funds stand to lose investors a lot of money. We estimate that if yields on long-dated gilts rise back to pre-QE levels, a typical lifestyle fund could lose 30pc of its value.

“The flip side is that if yields do rise, annuity rates should rise to at least partially offset this fall. However, retiring pension savers hoping to cash in on any annuity rate boon are unlikely to be impressed that their fund has fallen in value, offsetting any gain they might have expected.” There are other dangers that lie ahead. Take inflation, for example. Even at a modest level of 2.5pc, inflation will halve the value of a fixed annuity over 28 years. At 5pc it will halve it over 14 years. Ros Altmann of Saga said: “More than 90pc of those buying annuities are buying level incomes with no protection against inflation at all. This means that their future income will be permanently lowered by QE pushing up current inflation. And all those buying annuities after QE started will also have permanently lower future incomes as a result of the effect on annuity rates and future inflation.”

Later this year, the EU’s “gender directive” will equalise annuity rates for men and women, which is likely to push male annuity rates down. Male rates could fall by 5pc or possibly more; the Treasury has suggested that rates may fall by as much as 13pc. “Female rates may not initially rise by much, if at all,” added Mr Khalaf. Many pension experts reckon that the only way consumers will be able to improve their retirement prospects is if they are more flexible in their approach to annuities. Mr Burrows said: “Those approaching retirement are facing the ‘risk paradox’. Put simply, many people think that investing in a guaranteed annuity is the lowest-risk option. But looking to the future, the risk is that the spending power of a level annuity will be eroded by inflation and personal circumstances may change. Investors may have to take some risk with their annuity income. This is a hard message to sell and full of potential dangers. But it is an important message.”

Indeed, many people are being advised to adopt a flexible approach, such as via self-invested personal pensions (Sipps) and income drawdown. But, again, there are risks. The Financial Services Authority has already warned that there is the potential for consumers to suffer detriment by choosing drawdown rather than an annuity. The regulator’s unease is warranted, as it is easy to see why people may be tempted to sidestep annuities.

Show someone an illustration comparing the returns from a standard flat-rate annuity and an income stream based on returns of 7pc a year, and you will see the pound signs light up in their eyes. But as Your Money has highlighted in recent months, new rules on how much income you can draw down, coupled with stock market volatility, have left pensioners up to 40pc worse off each year. Planning your pension used to focus on salting away enough money so you would have a decent-sized pot when you stopped working. This is no longer the case. Retirement planning is moving to another level. It is a level that consumers need to grasp before it’s too late.

What are my options?

If your pension pot is less than £50,000, and you have no other sizeable savings, your best option is still to take the tax-free cash and buy a guaranteed annuity.

Deferring taking an annuity rarely pays, while drawdown is not recommended for people with smaller pension pots. “If you buy an annuity that is not guaranteed, the golden rule is to ensure that you have other sources of income or capital to fall back on if the future income falls in value,” said Billy Burrows of Better Retirement. Consider an inflation-linked annuity; experts admit that they do not look particularly attractive compared with a level annuity (£3,600 compared with £5,700 starting income), but they do offer some protection of your purchasing power.

“Alternatively, if you do opt for a fixed annuity, consider saving some of the income each year as a buffer against future price rises,” said Laith Khalaf of Hargreaves Lansdown. Whatever annuity you buy, shop around for the best rate – this could boost your retirement income by up to 40pc. Wealthier investors with an appetite for risk might consider a drawdown plan, which has the potential to provide a rising income.

Get expert help and advice – it could give you thousands of pounds more during your retirement years.

Original Article : Telegraph

By Paul Farrow, Personal Finance Editor