The income paid by annuities continues to fall, with several of the biggest providers slashing annuity rates in recent weeks.
Annuities are used by the vast majority of retirees to convert their life-long pension savings into a regular income for the rest of their life.
A small minority stay invested at retirement by going into some form of pension drawdown, while an even smaller number use a combination of annuities and drawdown. That option has become increasingly popular as more people seek an alternative to low annuities.
However, experts have warned that entering drawdown could for many people spell disaster later on in retirement, with the risk of pension savings being wiped out prematurely.
So annuities remain the only option for the vast majority of people at retirement. Some 5,000 people a week buy an annuity to turn their pension fund into a lifetime income.
But while the choice seems limited, the dilemma facing retirees is more complicated – and paved with more risks – than ever before.
Annuities are on a long-term slide, thanks largely to longer life expectancy. But the decline has accelerated alarmingly over the past year, due primarily to the Bank of England’s quantitative easing (QE) programme.
That’s because QE has been used to buy gilts, sending gilt prices up and yields in the opposite direction. Unfortunately for millions of pension savers, those gilts play a central role in the pricing of annuities, and they have plummeted accordingly.
Gemma Goodman, head of Alexander Forbes Annuity Bureau, said the top five annuity providers have all reduced their single life level annuity rates over the past month. Standard Life’s latest cut was by 5 per cent, slicing £250 off the annual income paid by an annuity bought with a pension of £150,000.
Things aren’t likely to improve any time soon, however. That means anyone retiring over the next year or so has some serious thinking to do before deciding how to use their pension pot.
For the vast majority of retirees annuities are the only suitable option. Only if you have a substantial pension fund and income to fall back on are the alternatives worth considering. But even with annuities you have choices to make, and there are a couple of things you can do to maximise the income you’ll get in retirement.
The first is to shop around for an annuity instead of taking the one offered by your pension provider. You have a right to do this – under the open market option – and with the best annuities on the market paying around 20 per cent more income than worst, it could make a real difference to your day-to-day finances in retirement.
If you’re with one of the firms that competes on annuities – such as Standard Life, Legal & General or Canada Life – you may be better off where you are. But it’s always worth searching the market to see if there’s a more generous option available. you can do this at pluto.moneyadviceservice.org.uk/annuities
If you smoke or you’re in ill health you can boost your retirement income further by purchasing an enhanced annuity. This will pay out more – considerably in some cases – on the basis that your life expectancy may be compromised.
Another option, if you can afford it, is to wait a while before buying an annuity in the hope that rates will rise again,
You’d be taking a risk as there’s no guarantee that they will. The rate of decline may well slow when the effects of QE wear off and gilt yields rise again, and providers could increase rates, but how much and when is a guessing game.
Most experts agree that the long-term trend is downwards.
One option is to buy a fixed term or temporary annuity. This is an annuity that pays an income for just five or ten years, rather than for life. That takes away the irreversible nature of the usual annuity purchase and provides the flexibility to see how things pan out with annuity rates. The likelihood is, however, that rates will be lower in five or ten years than they are now.
It’s possible to buy both a conventional annuity and a temporary one, using some of your pension to lock in at current rates while using another chunk to keep your options open for a few years.
Similarly, because you don’t have to use all of your pension fund at once you can buy one conventional annuity now and another at a later date.
That’s not the end of the decision-making process, however. You also have to think about the type of annuity you buy – and, again thanks to quantitative easing this is increasingly important.
By driving up inflation again QE could eat into the future income paid by annuities. Yet while inflation has combined with low interest rates to wreak havoc with pension income over the past three years, very few people buy annuities that have some inflation protection built in.
Inflation-linked annuities are unpopular because they mean less income now in return for income that rises later on in line with prices.
Inflation-linked annuities are usually the best option, according to Carl Melvin, chartered financial planner at Affluent Financial Planning in Paisley.
“But it’s very expensive and in my experience most people find the fall in initial income too great compared to level annuities,” he said.
That dilemma is typical of what, on the face of it, is a simple decision. Choosing to buy an annuity is one thing, but getting the most suitable deal for you demands a little bit of homework.
Melvin said: “The annuity market is affected by issues out with the average person’s control – the effect of QE, the gender directive, inflation and so on; that means the best course of action is to seek professional advice from an IFA to make the best of what you have.”