Annuity rates – which determine the retirement income of millions of pension savers – have fallen to their lowest ever level.
The continuing poor returns from annuities, as this article highlights – a new record low – are one of the driving factors behind Financial Intermediaries looking at alternative income streams for their clients. Alternative Investments can play a valuable role in a balanced portfolio and their use is generally understood to be on the increase, driven by the rise in the number of people holding a SIPP.
A 60-year-old man would now get an annual income of £5,340 from a fixed annuity, according to Alexander Forbes Annuity Bureau. This is the lowest figure ever recorded, the company said. Annuity rates could be pushed lower still when new EU rules on solvency come into force in 2014, according the Deloitte, the accountancy firm. Rate slumped by 3pc in six weeks from what were already historic lows. A fall of almost 2pc was registered in just 10 days. As a result, a 65-year-old man spending £100,000 to buy an annuity will now get an annual income of just £6,003.
In early 2010 the same pension pot would have produced an income of £7,157. That had fallen to £6,246 at the beginning of this year, then to £6,188 on the May 1. The main reason is the extreme dislocation in the market for gilts or British government bonds. These bonds are used to back annuities, but the yields keep hitting record lows as a result of the financial crisis. Investors are taking their money out of countries perceived as risky, such as Greece, Spain and Italy, and putting it in what they see as safe havens – Germany, Switzerland, the United States and Britain, for example. The flood of money into these bonds has pushed prices up, causing yields to fall correspondingly.As the eurozone crisis has intensified, gilt yields have fallen further still. The yield reached its lowest level since the Bank of England’s records began in 1703.
Annuity – It could get worse.
If investors start to regard Britain as a safe haven on a par with Germany or Switzerland, annuity rates could fall even further – currently investors receive no return at all on two-year German bunds. Annuities tend to be linked in practice to the yield on 15-year gilts, which currently pay interest at 2.2pc. Were that yield to fall to 1.5pc (the yield in Japan is currently 1.3pc), annuity rates would fall by about 5pc, estimated Billy Burrows of Better Retirement Group. This would mean that a £100,000 annuity would pay an annual income of just £5,700 for a 65-year-old man, compared with the current £6,000. But Ian Hammond, the head of Rowanmoor, added: “I find it difficult to believe that gilt yields would drop as low as 1pc.”
Tom McPhail of Hargreaves Lansdown said: “Could gilt yields go to zero, as in Germany? They could if we get a depression or deflation. So could annuity rates fall further? Unquestionably.” If rates did fall to even lower levels, annuities would simply not be worth buying, Mr Burrows said. Already the effective interest rate – the notional rate at which the annuity company pays interest each year on top of returning a slice of the capital – is about 2pc, assuming average life expectancy. If annuity rates fell by a further 10pc, that interest rate would be cut to 0.75pc, he said. At an annuity rate of 5pc, a 65-year-old man who lives for the average 20 years will receive zero interest – his capital will simply be returned to him at the rate of £5,000 a year.
Steve Lowe of Just Retirement said: “When you are seeking an annuity quote, there are three key questions to ask yourself: first, do I smoke; second, do I take any prescription drugs; third, have I had a stay in hospital in the past few years? If the answer to any is yes, tell the annuity company – you will almost certainly qualify for an enhanced annuity, which could increase your income by 10pc, 20pc or even more.” But there are other options apart from buying a conventional lifetime annuity. Mr Lowe added: “Many people retiring now, who cannot bring themselves to tie into today’s rock-bottom annuity rates for life, are keeping their options open by buying fixed-term annuities. These leave open the possibility of getting a better rate in a few years’ time, if rates have improved or, if their health has deteriorated and they now qualify for an enhanced rate.” Vince Smith-Hughes of Prudential pointed out that investment-linked annuities provided investors with a degree of guaranteed income and the potential for investment growth.
“As a halfway house between conventional annuities and income drawdown, they are designed to fit in with investors’ flexible lifestyles,” he said. There is, of course, also the risk that incomes could fall if the investments perform poorly. Gemma Goodman, head of Alexander Forbes Annuity Bureau, said: “With continued pessimism around a feasible resolution to a eurozone crisis that is dragging rates to further historic lows it is difficult to be optimistic about any potential increase in annuity rates. “This difficult situation further reinforces the importance of shopping around, considering your health and lifestyle conditions and possibly considering short term solutions when it comes to taking your retirement income.”
She added: “Although annuity rates are at a historic low, it is possible that they could continue to decline even further.”
Original Article : The Telegraph