BLOG: Will negative interest rates destroy annuities?
The main question, therefore, is whether such a shift in consumer attitudes towards annuities is justified. And with the possibility of negative interest rates, what does this mean for annuities going forward?
What are annuities?
An annuity is a financial product, which can be purchased by retirees using part or all of their pension pot. Prior to the introduction of Pension Freedoms in 2015, it was the norm for retirees to take out 25% of their pension savings as a tax-free lump sum, while using the other 75% to purchase an annuity.
However, the Pension Freedoms gave retirees more control over what they did with their pension savings. This meant they could explore more flexible options, such as drawdowns. With alternative retirement finance options readily available, people began to question whether previous retirement finance formulas were best suited to their individual needs.
Indeed, when one considers the greater context of what influences annuity rates, it is possible to understand why so many consumers questioned the viability of annuities.
The value of annuities
Annuities, as with other financial assets, are heavily affected by changes to interest rates. And for over a decade, they haven’t fared too well.
The Bank of England base rate of interest, which influences how cheaply banks can lend money and how much savers earn on their savings, has been very low for quite some time. From 2009 to 2015, base rates were held at 0.5%. To compare, rates were as high as 5% in 2008. Having fluctuated between 0.75% and 0.25% over the past four years, the onset of Covid-19 saw rates hit a historic low of 0.1%. Consequently, annuity rates have been pushed down.
Annuity rates are also affected by life expectancy. Put simply, as life expectancy increases, annuity rates decline. This is because the longer a retiree lives, the longer an annuity provider will have to pay them an income. So, a combination of millions of retirees living longer and longer into their retirement and low base rates inevitably lead to rock-bottom annuity rates.
Thus the industry has experienced a decrease in annuity purchases since 2015. Indeed, before the Pension Freedoms, annuity sales ran at approximately 350,000 a year; in 2018, just 33,975 new annuity sales were recorded.
Shopping around for the best deal
Although they might not seem as attractive as they once were, retirees should not immediately dismiss annuities as a potential source of retirement income. As annuities are the only pension product for consumers to ensure they receive a guaranteed income for life (on top of the state pension), they could de-risk many consumers’ retirement.
That’s why it is beneficial to investigate all of the options at hand before making a decision about your pension. Pension planners should be aware that they don’t have to accept the annuity that their existing pension provider or scheme offers to them.
Instead, consumers shouldn’t underestimate the importance of shopping around to find the best annuity rate. The rates offered by different providers can vary dramatically, as some specialise in certain areas, such as enhanced annuities – products tailored to those with a medical condition that shortens their life expectancy – or investment-linked annuities, while some might even take into account where you live. Put simply, by shopping around, some pension planners might be able to find a preferable rate.
Lock in now, or wait?
With the pandemic showing no signs of winding down just yet, many will be concerned that the fall in annuity rates is just the start of a larger collapse. As a result, consumers might wonder whether they should be locking in their annuity rate now or wait until the market has settled when considering their pension.
Given the current state of annuity rates, many will likely consider waiting before purchasing an annuity. However, this may not be the best strategy. Delaying the purchase of an annuity does not automatically mean consumers will enjoy a better rate; it is true that annuity rates may increase or that the individual’s health may worsen over and thus qualifying for a higher level of annuity rate; but this is by no means certain.
On the contrary, there is a possibility that annuity rates could worsen. This would mean that consumers could find themselves with a lower than expected retirement income, inevitably damaging the quality of their retired life.
That said, each individual will have a different set of circumstances, and when faced with difficult financial situations, it is important that consumers know they don’t have to navigate the complexities of planning their retirement alone.
Instead, consumers should seek sound advice from independent financial advisers to demystify market jargon. What’s more, seeking advice can essentially safeguard your financial position. If a consumer decides to follow any advice offered by an adviser and ends up worse off, the adviser in question must reinstate their original financial position. This enables more concerned retirees the flexibility to investigate their options with some added security.
Ultimately, the unprecedented market volatility we are currently experiencing should prompt consumers to re-assess the viability of annuities. Whilst they won’t suit everyone, they could provide consumers with the security of income for life. And indeed, such security could offer retirees peace of mind in such a turbulent time.
Andrew Megson is executive chairman of advised retirement income specialist, My Pension Expert