THE financial decisions facing Scots on the brink of retirement are becoming increasingly complicated after fresh cuts to the pension income paid by annuities.
The rates paid by annuities – used by the majority of people to convert their pension savings into a retirement income – have plunged to record lows in recent weeks, leaving retirees with an uphill battle when it comes to cashing in their pension funds.
Those difficulties are compounded by legislation changes and falling gilt yields that have driven down the income available from drawdown arrangements, the main alternative to annuities for those with a decent amount of savings.
Here is a rundown of what’s happening to retirement incomes, how it could affect you and what your options are.
Why are annuity rates falling?
They have been falling for 20 years, due largely to increased longevity. A 65-year-old man retiring with a pension fund of £100,000 in 1990 could have bought an annuity providing an income of £15,640 for life. A 65-year-old man buying an annuity on retirement today would get less than £6,000 a year.
Annuity rates have fallen by about 25 per cent in the past four years, hitting millions of pensioners. The decline has accelerated in recent months amid the fallout from the Eurozone crisis and the UK’s own economic woes.
More specifically, the problem is the government’s quantitative easing programme. The money it produces is used to buy gilts, pushing their price up and their yield down. As those yields are used as the basis for annuity pricing, providers have slashed their rates. The impact has been exacerbated by market volatility, which has eaten into the value of the pension savings with which many people are retiring.
Will they keep on falling?
Almost certainly, for a variety of reasons. The most obvious is the absence of a solution to the Eurozone crisis and the likelihood that a UK recovery is some way off, said Carl Melvin, director of Affluent Financial Planning in Paisley.
“Gilt yields are likely to fall further on the basis that the euro crisis will get worse, investors will seek a safe haven in sterling government debt and there will be greater demand for UK gilts. That means gilt values rising, yields falling and annuities are negatively impacted,” he said.
Other factors spell bad news for those hoping annuity rates will improve soon. They include new EU requirements forcing insurers to hold more reserves so they can withstand financial shocks, plus new rules on the use of gender in setting prices, which come into force on 21 December. Men get better annuity rates than women as they typically die younger, but such gender-based differentials will be outlawed under the new legislation. Experts believe that could cut a further 10 per cent or more from annuity rates for men.
I’m retiring in a few months. Should I delay buying an annuity?
It depends largely on individual circumstances and finances. If you’re retiring over the next year or so, the likelihood of annuity rates falling further means you might want to buy sooner rather than later.
That point is particularly pertinent if you have a modest pension and/or are risk-averse and don’t feel comfortable with remaining invested once you’re retired. However, many people may be tempted to leave their pension invested for longer if they’ve suffered losses in recent years and want to benefit from investment growth before cashing it in.
Tom McPhail at Hargreaves Lansdown said: “If you are willing and able to defer annuitising for an uncertain period of time, which could extend into years, then it may be advantageous to wait until rates improve.”
Hargreaves Lansdown’s website has a calculator to help you work out the potential cost of delaying your annuity purchase: www.hl.co.uk/pensions/annuities/annuity-delay-calculator.
You could also phase your annuity purchase, using some of your pension to buy one now and taking further annuities at a later date (probably at even lower rates).
Most annuities are for life, but some providers, including LV=, Aviva and Metlife, now offer fixed-term or temporary annuities, usually over five or ten years. But with rates falling over the long term, you’re likely to be locking in at an even lower income level once the term ends.
Brian Steeples, managing director of the Turris Partnership in Glasgow, said: “The new breed of temporary annuities are good in theory. Unfortunately the rates are terrible and provide less than cash interest returns.”
How can I get a decent deal?
With a difference of some 20 per cent between the best and worst-value annuities it’s vital to shop around, using what’s called the Open Market Option. Many retirees automatically accept the annuity offered by their existing pension provider, potentially costing themselves thousands of pounds, by failing to see if they can get a better deal from other providers.
Are all annuities the same?
No. Most people opt for conventional level annuities, which pay out the same level of income through retirement. However, inflation-linked annuities – starting at a lower level but rising in line with the retail prices index – are also a viable option. But some advisers suggest looking at other alternatives to the usual level income product.
Steeples said: “For most people, locking into a conventional annuity at this time is not sensible, given the extremely low interest rates.”
With-profits annuities are worth considering, he says. “These provide the opportunity for slightly higher income with relatively small fluctuations in income. Most importantly, they also allow a conversion option whereby a conventional annuity can be purchased in the future when interest rates are much higher.”
If you smoke or have health issues you should qualify for an enhanced annuity, which pays out a higher income on the assumption that your longevity is compromised.
What else can I do with my pension fund?
The main alternative is income drawdown – provided you have a decent-sized pension fund and can stomach the prospect of potential investment losses in retirement.
This is where you leave your pension invested and instead take money from it in tranches. However, the fall in gilt yields has also affected the amount of income that can be taken, as has a rule change last year restricting the proportion of the fund that can be drawn down.
Those factors have combined to slash the maximum income that can be taken by as much as 55 per cent, according to MGM Advantage.
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