Falling government bond yields and increasing lifespans are just two factors pushing down annuity rates.
Annuity rates are currently at the centre of a perfect storm:
- Yields on long-term government bonds are at historically low levels (see ‘How low can you go?’). For instance, 15-year gilts are currently yielding around 3%.
- Life expectancy continues to increase rapidly – witness the Government’s efforts to increase the state pension age.
· Forthcoming new EU rules, known as Solvency II, are making it more expensive for insurance companies to underwrite annuities.
- From 21 December 2012, all new insured annuities will have to be written on a unisex basis, meaning that men will no longer receive higher annuity rates than women of the same age.
For a man aged 60 with a pension fund of £100,000, the current top-of-market rate for a level (non-increasing) annuity is around 5.6%. The corresponding figure for a woman of the same age is 5.3%. Include inflation-proofing and these rates drop by nearly a half. If you are about to draw benefits from a pension plan, such numbers are not good news. They reinforce the need to review all your retirement income options. These include:
Open market annuities Not all pension plan providers compete in the annuity market. Therefore you should never accept the annuity rate from your pension plan company without first checking what is on offer elsewhere. Annuity rate setting has become increasingly refined in recent years. For instance, some companies now set rates according to your home postcode. If you are a smoker, or have less than perfect health, you may be entitled to an enhanced annuity rate. Annuity rate tables in the weekend press give a very limited snapshot and cannot show the full range of your annuity options.
Phased retirement Phased retirement involves drawing on your pension plan in stages, with each year’s ‘income’ consisting of a tax-free lump sum and annuity payment(s). This route has the advantage of avoiding the one-off annuity purchase, but it does involve investment risk. Part of your pension plan will remain invested after your retirement income begins and annuity rates could fall further.
Income drawdown Income drawdown – drawing your income directly from your pension fund – is normally only a viable option if you have other sources of retirement income. It offers considerable flexibility – if you have £20,000 or more of other secure pension income, you may be able to withdraw as much as you wish. Bear in mind that the charges are far more than for an annuity. However, the normal ‘capped withdrawal’ rules will limit your maximum initial income to much the same as an annuity can provide and income withdrawal arrangements virtually always carry investment risk. If you are concerned by the possibility that your income could fluctuate as a result of the ups and downs in the stock market, an annuity could be a better option.
In view of the complexities surrounding your retirement income choice, it is particularly important that you review your objectives and options with the help of expert pensions advice. Phased retirement and income drawdown are higher risk, more complex products and advice should be sought.
The value of your investment and the income from it can go down as well as up and you may not get back the full amount you invested. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances. The value of tax reliefs depends on your individual circumstances. Tax and pensions laws can change.