Annuity rate rises won’t last

Investors approaching retirement are being offered higher rates of income for the first time in nearly 18 months – but advisers warn they should buy an annuity soon, as the rises are unlikely to last.

Over the past month a number of annuity providers have increased their rates by 1.5 per cent on average (see box). In some cases, rates have gone up as much as 4 per cent.

Providers have started raising their rates because yields on corporate bonds and gilts, which insurers invest in to fund annuities, have risen and this has been fed back into annuity rates.

The increases in annuity rates are the first since June 2009, according to Hargreaves Lansdown, the independent financial advisers.

According to the firm’s annuity index, a 65-year-old man with £100,000 pension savings can now buy a level annuity of £6,428, compared with October’s low point of £6,291.

The rate rises will be welcomed by people approaching retirement who have seen their income prospects shrink following a number of downward rate revisions.

Currently, annuity rates are still 17 per cent lower than levels two years ago, when the same 65-year-old could buy an annuity for £7,755.

But many pension advisers don't believe the upswing will last.

“The rises are just a blip,” said Ros Altmann, adviser to the government on pension strategy and director general of Saga, a financial service provider for the over-50s.

“They might rise a little further over the next few months but beyond that I think the outlook is for continued falls.”

Some industry observers believe that long-term bond yields could go up as the effects of inflation, coupled with an expectation that interest rates will rise, take effect. But any increase may not be passed in full to annuities.

Billy Burrows, partner with Burrows & Cummins, the specialist annuity providers, says there are two reasons a rise in bond yields might not result in higher annuity rates.

First, insurance companies are setting aside more capital to back annuities in anticipation of the new European rules on solvency levels,

Second, life expectancy is still increasing.

Laith Khalaf, pensions analyst with Hargreaves Lansdown, also believes the case for rates falling back in the near term “is as strong, if not stronger, than the case for further rises”.

“Annuity providers do tend to exhibit a herd mentality, so momentum could push rates up,” he said.

“However, in recent times, the herd has appeared keen to cut rates but more reluctant to put them up. It may therefore be difficult for much upward momentum to gather.”

Another factor which could put downward pressure on rates is a decision next year by the European Court of Justice on whether annuity providers will be allowed to continue to offer better rates to men than women.

Men currently receive more generous annuities because they don’t live as long as women.

“In the short term, annuity providers could level down to the female rate for both men and women if insurers are no longer able to quote male and female rates,” warned Khalaf.

Individuals are currently obliged to buy an annuity by the age of 77 or go into an alternatively secured pension, which carries high tax rates.

The age rule is set to be scrapped from April 2011, giving retirees more flexibility over the use of their pension savings.

Only wealthy pensioners who do not rely on the state are expected to be able to take advantage of these freedoms, however, with the majority expected to continue to buy an annuity at retirement.

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