Pension savers are being urged to consider alternatives to buying a lifetime annuity with their funds, after rates suffered their biggest monthly fall on record – to reach a new low.
In August, the typical annuity income a 65-year-old male could expect to buy with a £100,000 pension fund fell by 5 per cent, or more than £300 per year, according to new figures released this week.
This would mean £9,000 less income over a 30-year retirement for a pension saver who locked into an annuity rate in August, instead of July.
Last month’s drop in annuity rates is linked to the record low returns that insurers are now receiving on gilts – the government bonds that are used to back annuity payments.
Gilt yields have fallen as investors have sought a safe haven from the Eurozone debt crisis by buying UK bonds.
Combined with the high levels of stock market volatility experienced in August, these plummeting annuity rates have meant investors approaching retirement who did not switch out of equities and into gilts or cash face a “double whammy”: diminished pension funds, that now buy them less income.
“It is very disappointing that there has been another drop in many people’s pension funds,” said Gemma Goodman, head of The Annuity Bureau, the independent financial advisers. “It is worth considering delaying a purchase of an annuity if your circumstances allow it. However, for funds to recover, in some instances this could take a number of years – and there is nothing to say that we won’t be affected by further downturns.”
New rules that came into force in April mean that pension investors are no longer forced to convert their funds into an annuity at the age of 75, but can instead remain in income drawdown.
Despite this, most individuals still buy an annuity, to secure an income for life, at retirement. However, with annuity rates now at record lows, and forecast to fall further, some advisers say those approaching retirement should reconsider whether a guaranteed annuity rate is the best option.
“Although annuities pay a guaranteed income for life, investors will be locking into the current low yields – with no increases if yields increase in the future,” said Billy Burrows of William Burrows Annuities, the specialist pension advisers. “The alternative to a guaranteed annuity is an investment-linked or fixed-term annuity. These annuities do not guarantee the level of payments but have the potential to pay a higher income in the future, if investment returns or annuity rates are higher than they are now.”
But Burrows added that investment-linked annuities carry more risk: the downside is that future income could be lower, not higher, if investment returns or annuity rates continue to fall.
Individuals who are not comfortable with this risk and need a retirement income now are being advised not to delay an annuity purchase.
“Analysts are predicting that annuity rates could continue to fall, further adding to the cost of delay,” warned Dean Mirfin of Key Retirement Solutions, the retirement advisers. “Another 3 per cent fall in the next three months would cost pensioners £200 a year.”
Pensioners who choose to delay an annuity purchase in the hope of securing a better rate when they are older need to weigh the costs of this decision, explained advisers.
“There is also a risk that, even by purchasing an annuity at a greater age, the increased rate you would gain may never make up the income lost by delaying purchase of an annuity,” added Goodman. “In our experience, it is also not possible for many people to wait. They have planned their retirement and need a regular income so the choice to delay may not even be available. Either way, you should carefully consider your options and seek specialist advice before making a decision.”
Individuals who are in poor health, or who smoke, could gain up to 40 per cent more income than a standard annuity can offer by opting for an enhanced annuity, said advisers.