Pension Annuity Rates: Why They Won't Rise

Pension Annuity Rates: Why They Won’t Rise
Tawali Papua New Guinea by Julian Cohen. Why?

Although pension annuity rates tumbled with the fall of interest rates, chances are they won't recover, even if the cost of borrowing increases

If you're yet to buy an annuity, it's vital you understand what's going on with pension annuity rates, for it could be the single, most important investment you ever make

Despite the Bank of England holding interest rates at a record low of 0.5% for another month, as the UK economy becomes stronger, the prospect of a rise in interest rates looms nearer. This should be good news for pensioners, but sadly, this might not be the case.

The majority of people still buy an annuity when they retire, even though pension annuity rates have plummeted in value in the last ten years.  Unfortunately, there's no sign of them returning to their 2007 peak at any time soon.

So What's Going On 'Under The Bonnet'?

When you buy a pension annuity, your income is linked to interest rates. Specifically, it’s linked to the yields on Government bonds or gilts.

When interest rates and yields on gilts collapse, pension annuity rates also collapse. Not only has the Bank of England kept interest rates at an historic low for the past four years, it has also kept gilt yields low by pumping £375 billion into the economy via its quantitative easing programme.

MGM Advantage, a leading pension annuity provider has revealed that since quantitative easing started in March 2009, the yield on 15-year gilts, which annuity providers follow, has fallen by 20% and pension annuity rates have fallen 15%.

In financial terms, the income from a pension fund of £100,000 for a 65 year old has fallen from £6,930 a year in 2009, to just £5,877 today.

It's Not All Doom And Gloom

Whilst Mark Carney, Governor of the Bank of England is committed to keeping interest rates low until unemployment falls, there is some positive signs surrounding gilt yields.

They hit an all time low of just over 2% in August 2012, but since then, they have improved quite a bit, currently standing at around 3.3%. The increase has been due to a slow but apparently strong rise in the value of the economy, and talk of the end of quantitative easing. 

Most experts agree that when quantitative easing ends, gilt yields and interest rates will rise. And that will improve the returns from pension annuity rates for people retiring.

Some Experts Aren't Convinced

Pensions expert Ros Altmann said current pension annuity rates were ‘outrageously poor value’ and even though gilts yields have risen significantly, annuities haven’t kept pace.  ‘Annuity rates followed interest rates all the way down, but they are not following gilt yields up,’ she said.

Altmann went on to say this. ‘My expectations are that gilt yields will go back up, but I do not think the Bank of England will unwind quantitative easing because it will be a catastrophe. The Bank will find a way of rolling it over, but they will need to issue new gilts which will push the yields up.’

MGM Advantage's pensions technical adviser, Andrew Tully said pension annuity rates would struggle. ‘I think annuity rates will edge up by the end of the year, and again next year, but they won’t get back to anywhere near historical highs of 15% in the 1990s, and I don’t think they will even get back to the highs of three years ago when they stood at 7%. They may get back to 6% or a bit higher.’ he said.

Downward Pressures On Pension Annuity Rates

Pension annuity rates may have a bit further to rise. But there could be some factors that could offset some of the benefits of gilt yield and interest rate increases.

New European capital rules are being introduced in 2016/17, requiring insurers to hold more capital.  This will incur them in massive expense which will inevitably be passed on to consumers. The timing of this cost is very unfortunate, for most experts predict interest rates will rise at this time.

Recently, there's been a big increase in the number of enhanced pension annuity rates, paid to less healthy people.  If you're ill, that's great for the rate, but as the cost of the income is spread across both healthy and unhealthy people, those who enjoy good health will inevitably receive less money.

As interest rates increase, there's a risk that inflation could rise with it.  And that means those in retirement will find their 'fixed' pension annuity rates buys them less and less as time passes.

As a result of these and other factors, it's possible that annuity providers may move away from traditional pricing of pension annuity rates. In future, some experts believe pension annuity rates may be calculated on a more personal basis, similar to the way that car insurance works. 

If You're Yet To Retire, Learn About Your Options

As people live longer, to offset rising costs throughout a very long retirement, many predict that more people will take advantage of investment-linked annuities, where some of the pension remains invested.

For those with larger funds and the willingness to continue to manage their money, Income Drawdown will continue to remain a viable alternative.

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