Quantitative easing has hit pension annuities as gilt returns fall

Published on Friday 4 September 2009 21:01

THE Bank of England decided recently to inject a further £50 billion of new money into the economy as part of its programme of quantitative easing. This may be good for the economy but how will it affect your pension?

Whether you have a personal pension plan or belong to your employer's group scheme, your retirement fund will likely depend on the value of your pension fund and annuity rates when you retire, with most final-salary schemes closed to new members and more now closing to existing members.

About 600,000 people with money purchase pension plans, which offer no guarantees about the amount of pension you will receive, are expected to retire over the next year. When they do, most of them will buy an annuity with their fund and this will provide them with their pension income for the rest of their life.

Annuity rates depend on a number of factors including your age, gender, marital status, health and, increasingly, your postcode.

However, one of the most important factors is the annual return or yield on government bonds (gilts). This is because, when you buy an annuity, the insurance company uses your pension fund to buy gilts in order to pay out your pension each month. If the return on gilts is low when you buy your annuity, this will lead to a lower pension for the rest of your life than if you had bought an annuity when the return on gilts was higher.

Since March interest rates have sat at 0.5 per cent, the lowest level in the Bank of England's 315-year history.

The Bank is also trying to bring down the longer-term interest rates on which annuity rates are based by the policy of quantitative easing.

The aim is to stimulate the economy by reducing the cost of borrowing for companies and individuals. It does this by pushing up gilt prices and reducing gilt yields, which fell dramatically in the days after the Bank first announced its plans to pump 125bn into the economy at the beginning of March.

This led to a fall in annuity rates, which means that every pound of your money purchase pension fund will buy a lower pension than if you had retired this time last year.

Your pension fund has probably also been affected by the volatility in stock markets over the past 12 months. If you are approaching retirement you may have some difficult choices to make and, for some people, this may mean carrying on working.

Some people with larger pension funds may decide not to purchase an annuity and draw down income from their personal pension fund instead.

The maximum income they can take is based on tables compiled by the UK government actuaries department and the calculations take into account the yield on 15-year UK gilts. A year ago the yield on 15-year gilts was 4.89 per cent. This has since fallen to 4.21 per cent, a reduction of almost 14 per cent.

This means your pension income may well be affected by quantitative easing and the resulting fall in gilt yields, whether you buy an annuity or draw down income from your pension fund.

An independent financial adviser will be able to advise you on your options as you approach retirement to ensure you make the most of your pension fund.

&#149 Sue Hussin is an investment adviser with Johnston Carmichael Financial Services.