Annuity cuts bad news for pensions

Published on Friday 12 September 2008 19:14

ANNUITY rates are heading down again after reaching a six-year high, pension investors have been warned. Seven of the biggest annuity providers have announced rate cuts in recent weeks, although rates remain 5 per cent higher than at the start of this year.

The cuts, prompted by a drop-off in gilt and corporate bond yields, have been in the region of 2 per cent, but over 20 years or more of retirement that adds up significantly.

And the chances are that annuity rates could return to their long-term downward trend, according to Nigel Callaghan, pensions analyst at Hargreaves Lansdown. "Predicting the future direction of annuity rates is virtually impossible. However, on the balance of probabilities, rates are more likely to fall as the historic high spreads and yields of gilts and corporate bonds narrow," said Callaghan.

There's little to suggest that the long-term direction of annuity rates is anything but down. The Office of National Statistics recently revealed that, for the first time, the UK has more people of pensionable age than children under 16. Over 80s are the fastest-growing age group and with life expectancy continuing to grow, insurers have to pay out annuities for longer, increasing the pressure on them to lower the rates they offer.

The fact that seven insurers cut rates in the space of one month has compelled some annuitants to lock in now instead of delaying their annuity purchase. "We've seen an increase in annuity purchases this year as people have sought to lock in to the higher rates, while the turbulent stock markets have also added to the security attraction of annuities," said Callaghan.

"We've also seen a number of investors hedging their bets by buying an annuity with at least part of their pension savings, so locking into rates that are at a six-year high without converting their pension fund all in one go.

"This secures the rate for the rest of their lives, irrespective of what happens to rates in the future."

But attempting to time annuity purchase in a bid to capture a high rate is pointless, warned Gerry Devenney, principal at Punter Southall in Edinburgh. "It's tempting to wonder if you can get a good deal, but there are too many players and different rates. Whether you should buy now is only half the equation – you also need to think about what your pension fund is doing. Depending on your time horizon and scenario, it could be the worst time to crystallise investment losses by buying an annuity."

In any case, those buying annuities now could still encounter problems doing so. The Financial Services Authority recently reported that six out of ten customers converting their pensions into annuities face delays in receiving their payout due to complexity, confusion and paperwork.

With rates likely to fall again, pensioners could lose up to 10,000 over the course of their retirement if their payouts are delayed, estimated Virgin Money. A 100,000 lump sum could currently buy a level annuity for a 65-year old man of 7.74 per cent. A rate drop of 0.5 per cent during the transfer period would cut the rate to 7.24 per cent, amounting to a loss of 500 a year, and 10,000 over 20 years of retirement.

The FSA also said that 40 per cent of the "wake-up" packs sent by insurers to explain to pension holders before retirement failed sufficiently to explain the open market option, which allows annuitants to buy from across the market rather than be tied to their existing pension provider.

With a difference of some 20 per cent between the best and worst annuities, shopping around can make a big difference. As the annuities market becomes more segmented – some insurers are introducing postcodes into the pricing process – understanding what's available will become even more essential in securing a decent retirement income. "The dynamics will change as more providers offer different pricing," said Devenney. "People will be able to take advantage of the opportunities presented, but if they don't, regular rates will become far worse than before."

Case study: Downturn made him look to funds

AS AN ex-personnel director and pension trustee, 65-year old Colin McGrath knows a thing or two about pensions, but he admits that he isn't so clued up about annuities.

Although he still carries out some work as a judge in employment tribunals, 65-year-old McGrath retired last September. Over the course of his career, McGrath of Kelso, built up two pension pots but his tribunal work meant he was in no rush to purchase an annuity with his pension funds.

As the market downturn gathered pace, however, eroding some of the value from his pensions, he decided in January to bite the bullet, taking an annuity with Norwich Union.

A number of annuity providers have been accused of dragging their feet over annuity transfers, but McGrath, whose pension pots were with Norwich Union and Standard Life, found the process straightforward. "Within a month of deciding to buy an annuity I had it set up. By buying in January I lost out on the rise in annuity rates in the last few months.

"But because of the downturn my pensions fell in value by more than 5 per cent, so delaying taking an annuity actually cost me," explained McGrath.

As inflation has risen, many annuitants have opted to protect their income by buying inflation-linked annuities, but McGrath decided against this.

"I felt the reduction from making it inflation-proof was disproportionate to the benefit.

"The level annuity means the income is better upfront and I'd rather have it that way than delayed."