Boost for retirees as annuity rates rise again
Annuities are insurance policies that convert your pension pot into a guaranteed income for life.
They used to be popular products until pension freedoms, introduced in 2015, made drawdown – where your pension savings stay invested – accessible to more people, not just those with very large pots.
Annuity rates determine the amount of income you get in return for your life savings. Rates fell to an all-time low in September 2016 following the EU referendum result but have started to make a comeback.
Data from financial data firm Moneyfacts shows the average annual annuity income rose by between 1.4% and 4.8% in the first half of the year. It is up 14.6% since the Brexit vote and is now just 1.2% lower than when pension freedoms came in.
According to Moneyfacts, a 65-year old with a £10,000 pension pot would now get £476 a year up from £473 in April – a 0.6% increase. Or £2,626 compared with £2,594 for a £50,000 pot, a rise of 1.2%.
Richard Eagling, head of pensions at Moneyfacts, said: “Despite their much-reduced popularity, annuities remain the only at-retirement product that enables individuals to insure against investment and longevity risk.
“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. Here the focus remains on whether rates are sufficiently high enough to tip the balance of power back towards annuities.”
Will rates carry on going up?
With annuity rates steadily rising, the question now is: do they have further to go?
Last week’s Bank of England base rate rise raised the prospect of higher annuity rates.
Interest rates are one factor providers take into consideration when calculating annuity rates. When you hand over your pension savings to a company in return for an annuity, it invests your money in UK government bonds as these are considered relatively safe investments.
Yields (or income) on UK government bonds have been at record lows because of ultra-low interest rates so the amount providers can pay out has been low. But a rise in interest rates should boost gilt yields and, in theory, improve annuity rates.
However, an immediate uplift has failed to materialise so far, with gilt yields actually falling since the base rate announcement.
John Lawson, head of financial research at pension firm Aviva, said: “Annuity rates are driven by long-term rather than short-term interest rates such as the Bank of England base rate.
“Long-term interest rates may rise if short-term rates begin to rise, but in the case of last week’s base rate rise, the reaction of long-term rates has been muted a) because economic signals are mixed and b) the Bank of England has signalled that further rate rises are not imminent.”
He added: “One of the biggest influences on long-term interest rates is inflation. If inflation is rising and expected to stay higher, long-term interest rates will rise. However, inflation has been falling, which tends to have the opposite effect of depressing long-term interest rates.”
Fiona Tait, technical director at Intelligent Pensions, said: “The recent rise in the interest rate obviously raises the prospect of better annuity rates in the second half of the year, which could be enough to convince some of the people currently in drawdown to opt for guaranteed future income.
“It should be remembered however that rates are still relatively low in comparison with previous years and that the annuity rate is only part of the equation when making the one-off decision to fix future income.
“An annuity is the one retirement income solution that can mitigate longevity risk and for many people, securing income for life will be a priority in the later stages of retirement when income needs are less likely to fluctuate, and the desire for certainty increases.
“We often say it is not whether but when somebody should buy an annuity that is the most important consideration. Those who have accessed their retirement pots in their 50s and early 60s should not be rushing to take advantage of the increases unless it suits their wider income goals.”