With the recent stock market turbulence wiping an estimated £300bn from the retirement savings of millions of investors, those looking to get an income from their pension pot have been dealt another blow with annuity rates now at their lowest for 20 years.
A single life, level annuity for a 65 year old man with a pension pot of £100,000 would pay an income of just £6,160 a year, according to data from annuities expert William Burrows. In 1990, the same level of savings bought an income of £15,640, 153% higher than today.
Worse still, annuity rates have been falling rapidly over the past few years. In 2008, a £100,000 pot would buy a 65 year old man an annual income of £7,340, meaning than annuity rates have fallen by 16% in the past three years.
So what can you do if you’re reaching retirement and want to get an income from your savings? Which? Money guides you through the annuities minefield and how to get the best deal for your later years.
What is an annuity?
An annuity is a financial product that allows you to exchange the lump sum that you’ve saved up for your retirement- often called your pension pot- for a regular income for the rest of your life. The rate you get depends on the age at which you purchase the annuity and your state of health – insurance companies will assess how long they think you’ll live for and decide how much money you’ll be able to get based upon that.
Are there different types of annuities?
There are lots of different types of annuities and each have different rates of income attached to them. The annuity we described earlier, known as a single-life level annuity, is a straight forward product for somebody in good health. Enhanced annuities pay higher rates of income for those who are in poor health or smokers, as insurance companies think they are likely to have a shorter life expectancy.
Joint annuities pay an income to both you and your partner, and will have lower rates as they need to account for two people. Index-linked annuities increase your annual income to keep up with inflation, thus they are offered to people at lower rates than level annuities. Learn more about the different types of annuity.
Why are annuity rates falling?
Insurance companies mainly buy government bonds, called gilts, to fund the annuities they offer to people. Gilts are loans to the government for when it wants to raise money, and in return it pays interest back to its lenders. Insurers use them because they pay a fixed rate of interest over a set period of time and are lower risk (as the potential for the UK government not being able to pay back its debts is very low).
The rates of interest that gilts pay is connected to the Bank of England base rate, inflation and demand for the government bonds themselves. With interest rates currently at record lows as well as low inflation (in comparison to 20 years ago, when it was over 10%) and a lot of stock market turmoil, demand for gilts has increased enormously. This in turn has depressed the rates of interest they pay (called the yield) causing annuity rates to fall.
What can those approaching retirement do about low annuity rates?
The first consideration might be to delay retirement until annuity rates increase. This means that your retirement savings will remain invested and have a chance of growing a little bit more until you decide to buy an annuity.
For those that have a mixture of a final salary (defined contribution or DB) pension and defined contribution (DC) pension schemes, you could take an income from your DB pension and leave your DC pension invested until annuity rates pick up.
You could also split your retirement savings up, and only use part of it to get an income and leave the rest invested elsewhere. This means that you haven’t locked all your money into a lower rate.
How do I find the best annuity rate?
With most pensions, you automatically have what’s called an ‘open-market option’ (OMO). This means you don’t have to take the pension income offered to you by your pension provider but have the right to take your built-up fund to another provider to get a higher annuity rate. Moving to a new provider doesn’t always give the best rate, as some old policies have guaranteed annuity rates (GARs) that are unbeatable but it’s vital that you shop around to check the best annuity rate you can get, as it’s a decision you can’t reverse. Once you have purchased an annuity your money is tied up.