Retirees make their move as the market recovers

Published on Friday 11 September 2009 19:52

RETIREES who delayed annuity purchase until their pension funds recovered some of the value lost in the downturn are now making their move, following signs of a market recovery.

With annuity rates falling, thanks partly to the government's quantitative easing (QE) programme, those holding out until their funds have fully recovered face a crucial dilemma.

Annuity rates have been hit by QE because they are funded by gilts, yields on which have dramatically dropped off since the Bank of England began the QE programme earlier this year.

QE involves the government buying gilts in the market, pushing down the yield on them and forcing insurers to cut their annuity rates accordingly. The best annuity rate on offer to a 65-year-old male has fallen from 7.92 per cent a year ago to 7.17 per cent now.

Recent stock market rises – the FTSE 100 has jumped from its March nadir of 3,512 to pass the 5,000 mark this week for the first time in almost a year – have sparked a surge of interest in annuities from retirees who were waiting until their pensions recovered from the worst of the downturn before taking their benefits.

Adrian Lowcock, senior investment adviser at Bestinvest, said: "The stock market rally will not significantly affect the annuity rates but it will mean investors have a bigger pension pot with which to buy their annuities. Instead of getting 4 per cent on 100,000, for example, they may be able to get 4 per cent on 125,000."

Nigel Callaghan, pensions analyst at Hargreaves Lansdown, also reported a notable increase in the number of investors wanting annuity quotes.

"There are signs of a possible recovery and this will have fed through to investor's pension savings meaning that they can now bring forward their retirement plans."

With inflation likely to rise sharply in the coming years and annuity rates heading down, what kind of annuity to buy is the big question. Currently, the impact of inflation is a major consideration. A fixed escalating annuity, where the income paid increases by a certain amount a year – usually 3 or 5 per cent – can provide a useful halfway house between a level and an inflation-linked annuity.

But few people incorporate inflationary increases in their annuity purchase as it significantly reduces the income level in the early years, said Iain Wishart, chartered financial planner and proprietor of Wishart Wealth Management in Edinburgh.

For example, for a healthy male aged 65 buying a traditional annuity without guarantee or escalation the annuity rate is currently 6.74 per cent, giving a level income for life of 6,743 a year (gross). If the same male incorporates inflation increases then the initial income drops to 4,162 – a reduction of over 38 per cent.

Traditional level annuities remain the benchmark against which other options are measured, said Wishart. "There is yet to be the case where a UK insurer has defaulted on an annuity payment for a traditional annuity so they are seen as a safe option, although lacking flexibility."

A growing number of retirees in Scotland are eligible for an enhanced or impaired annuity, albeit few are taking advantage. These are aimed at smokers or those in ill-health and pay out more assuming a shorter pay-out period. Recent research by MGM Advantage found that the average enhanced annuity pays out 22 per cent more than a level annuity, meaning a 65-year-old man with a 50,000 fund would get an extra 715 a year in retirement.

Over 1,500 conditions can qualify annuitants for the enhanced rate, but low awareness of the option means many of those eligible miss out.

Similarly, the majority of retirees buy their annuity from their existing pension provider, neglecting to use the open market option (OMO) to shop around for a better deal. Investors with the most competitive providers – including Aegon, Aviva and Legal & General – are often better off staying where they are, but others can boost their retirement income by up to 20 per cent by finding a better deal.

The FSA's Moneymadeclear website – www.moneymadeclear.fsa.gov.uk – has comparison tables allowing consumers to search for the best annuities around.

Whatever kind of annuity you buy, it's worth looking into it sooner rather than later even if you don't want to buy one now, Wishart warned.

"Given that many insurance companies take weeks, and in the case of a few, months to issue retirement figures we recommend exploring the options six months prior to taking all or some of the benefits."