Pension income hit by new round of QE

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Savers approaching retirement now face difficult decisions over how – and when – to take their pension income, as annuity rates are set to be driven lower by the latest economic stimulus measures from the Bank of England.

This warning came from pension advisers after the Bank of England extended its asset purchase programme, known as quantitative easing (QE), by a further £50bn on Thursday.

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QE has been used by the Bank since March 2009 to stimulate the economy indirectly through the purchase of government bonds, or gilts, held by commercial banks and other business. By buying up these assets, the Bank has aimed to increase the supply of money in the wider economy.

But an unwelcome side-effect of QE has been to drive up the price of gilts, pushing their yields down to record lows – and, with them, the income paid by pension annuities.

Savers in personal or workplace defined-contribution pensions typically use their accumulated funds to buy annuities, which provide an annual income in retirement. However, as annuity income is partly determined by gilt yields, the income offered to those approaching retirement has fallen by 20 per cent in the past three years.

Hundreds of thousands of individuals who have bought lifetime annuities since QE began have locked into lower rates for the rest of their lives.

For example, a 65-year-old man with a £100,000 pension pot could have secured an annuity income of £6,930 in March 2009 when QE was started. Three years later, the same man would have been offered £5,850.

Retirees who have chosen not to buy an annuity, but instead kept their funds invested and used “income drawdown” to withdraw cash, have also been adversely affected by QE – because the gilt yields also determine the income drawdown limits.

Advisers said they expected this week’s fresh round of QE to cut the income of those hoping to retire soon.

“We would expect a further fall in gilt yields following an announcement of additional QE and, in a short space of time, this would be expected to feed through into lower annuity rates,” warned Tom McPhail, head of pensions research with Hargreaves Lansdown, the independent financial advisers.

Listen to Josephine Cumbo on how savers will be affected by the new round of quantitative easing on the FT Money podcast

Those nearing retirement therefore face a dilemma over when to time an annuity purchase, if they are set on buying a secure income.

Some analysts have suggested that annuity rates could rebound in future, arguing that gilt yields have been artificially depressed by QE. But forecasting future annuity rates is complicated by the fact that income levels are also affected by other factors – including the introduction of “gender neutral” rates, which are expected to cut annuity rates for men, but boost them for women.

“Those looking to retire are really caught between a rock and a hard place,” said Billy Burrows, director with the Better Retirement Group. “For most people, the issue is how can they secure a decent income today but have the flexibility to benefit in future if annuity rates rebound.”

Advisers say there are several options open to individuals who do not wish to lock into annuity rates at today’s prices.

First, retirees can buy a fixed-term annuity, which will provide secure income payments for three years, or more. At the end of the term, there is a guaranteed maturity payout which can be reinvested in another annuity or drawdown plan.

Second, savers who want more income and more flexibility than a conventional annuity offers can consider flexible annuities. These work differently to conventional annuities, as they allow investors to keep some of their pension fund invested in the stock market – giving scope for growth while guaranteeing a minimum income level.

Third, those who are intent on buying an annuity can compare quotes from all providers using the “open market option”.

“The difference between the best and worst rates can add up to thousands of pounds, especially for people who qualify for enhanced rates due to medical or lifestyle conditions,” said Andrew Tully, director at MGM Advantage, a pension provider.