Should the recent interest rate rise boost pension savers’ hopes of an annuity rate rebound?
While you are no longer compelled to buy one with your pension savings, an annuity can still play an important part in retirement planning. Indeed, if you don’t have a final salary pension, an annuity is still the only retirement option that guarantees an income for life, with no risk of running out of money.
If you're in the market for one, you’ll want to keep an eye on what's happening with annuity rates, as this determines the amount of regular income you will get in return for your pension savings.
Annuity rates are priced in relation to the yield on long-dated government bonds, otherwise known as gilts. If gilt yields fall or rise, annuity rates fall or rise with them.
The aftermath of the financial crisis saw interest rates cut to prolonged and record lows. This pushed up the prices of gilts and sent yields tumbling, reducing the incomes of those who chose to buy an annuity.
The effects have been severe. Back in November 2008, a 65-year old man with a £100,000 pension pot could have purchased an annuity paying £7,908 a year for the rest of his life. By March 2013, the same £100,000 would have bought an annuity paying an annual income of just £5,373.1
Shortly thereafter, the pension freedom reforms of 2015, which removed the obligation to buy an annuity at retirement, caused a collapse in sales. When the Bank of England then cut interest rates to 0.25% after the EU referendum result in 2016, annuity rates hit an all-time low as all the top providers cut income levels by between 2% and 3% on the back of the dramatic drop in gilt yields.
However, over the past 18 months, the market has witnessed a slow but steady improvement. According to data from Moneyfacts, the average annuity now pays almost 15% more than two years ago; and if this trend continues, it would mark the second year in a row in which annuity rates have risen – the first time this has happened since 2007.2
Depending on how the market views the likelihood of further base rate rises, annuity rates may continue to creep up.
Richard Eagling, head of pensions at Moneyfacts, says: “Despite their much-reduced popularity, annuities remain the only at-retirement product that enables individuals to insure against investment and longevity risk.
“[With rates on the up, this] raises the question as to whether an annuity would be a more suitable option for risk-averse retirees currently holding cash in their drawdown plans for no long-term strategic reason,” he says.
Ian Price, divisional director at St. James’s Place, says: “It is too early to predict significant increases in annuity rates but there are some signs that the tide may be about to turn, and annuities may start to recover some of their lost popularity.
“The security of an income guarantee to help cover essential outgoings is just one of the considerations in creating the right solution for generating income in retirement. How this might be combined with drawdown to create a mix-and-match strategy is just one issue on which advice is crucial.”
1 Sharingpensions.co.uk, based on a 65-year-old male in good health, buying a level, single life annuity with no guarantee period, 15 August 2018.
2 www.moneyfacts.co.uk, 07 August 2018.