Pension savers have been rocked by a fresh plunge in annuity rates that experts warn is set to continue as government reforms threaten to leave many workers worse off.
The rates paid on annuities, with which most private-sector employees convert their pension savings into a regular retirement income, last month suffered their biggest monthly fall in three years, new research shows.
The average level annuity rate dropped by 2.6 per cent in August, according to Life and Pensions Moneyfacts. For the typical 65-year old cashing in a £50,000 pension pot last month, that translated into lost income of £1,540 over the next 20 years, it said.
The report was published amid growing fears that some people nearing retirement could see their pension pots hit by market volatility in the wake of a Yes vote in the independence referendum.
The latest decline in the income available from annuities, which ends a recent spell of increases, is attributed to a reduction in gilt yields – on which annuity prices are based – and lower demand for annuities.
The latter factor is down largely to government reforms taking effect next April giving savers more freedom with their pension savings.
Under the changes, announced in the March Budget, retirees will be allowed to cash in their entire pension pot from the age of 55, including 25 per cent tax-free. The remainder will be taxed at the individual’s marginal rate, rather than the current 55 per cent.
Changes already implemented have made it easier to enter drawdown, where income can be taken from funds that remain invested, and to cash in small pension pots.
Insurers report that many retirees are holding off buying an annuity so they can take advantage of the new rules. The Association of British Insurers this week revealed that annuity sales plunged by 37.5 per cent in the three months to the end of June.
Richard Eagling, head of pensions at Investment, Life and Pensions Moneyfacts, said: “Although many individuals approaching retirement will be looking to postpone their decision on how to take a retirement income until then, the significant fall in annuity income that we saw last month will be felt by those who require a guaranteed, secure income now.”
And with demand likely to continue on a downward spiral, the outlook is bleak for the many retirees for whom annuities will remain the best retirement income option – often those without the means to take advantage of the proposed freedoms.
“These are testing times for the annuity market and we expect that pricing annuities will remain challenging until the new pension freedoms are introduced next April,” said Eagling.
Malcolm McLean, senior consultant at Barnett Waddingham, warned that by driving down annuity demand, the Budget reforms would “undoubtedly influence providers in cutting their rates”.
Those who need the certainty of income that an annuity provides might be better off buying one sooner rather than later, according to David Gow, a chartered and certified financial planner at Acumen Financial Planning in Edinburgh.
“More people than ever are aware of pension rules and are thinking about withdrawing funds rather than securing a lifetime income but for those with a cautious risk appetite who want to ensure they never run out of money, an annuity remains by far the best option,” he said. “You could convert now to save having to lock in at even lower rates or hedge your bets by using just part of your pot to buy an annuity and bide your time with the rest,” said Gow.
Most people with pension savings below £100,000 but who need some cash now are taking advantage of the current ability to take 25 per cent of their pot tax-free and leaving the remainder invested for the time being.
“However, you must seriously consider the death benefits,” warned Gow. “If pension savings have been crystallised, a 55 per cent tax charge on the residual pot is applied upon death. Uncrystallised pensions will not have any tax charge.”
Some savers nearing retirement are also vulnerable to the potential for a Yes vote next week to have a negative impact on pension fund values.
“There is the possibility of a wobble in the markets – share prices could plunge,” said Gow. “More so than ever diversification of investments, especially from a global point of view, is an investor’s best friend right now.”