Annuity income rates squeezed by Brexit vote

Patrick Connolly, certified financial planner at Chase de Vere, believes that for many people buying a lifetime annuity continues to be the best way to access some, or all, of their pension pot. In particular, the guaranteed income that an annuity provides makes it an effective solution for people who want to manage their living costs in retirement.

"People shouldn't be gambling with the income they might need to pay their day-to-day bills and living expenses," he says. "An annuity is the only way to guarantee a secure income for the rest of your life. If you select any other option you are taking more risk and could potentially be gambling with your standard of living in retirement."

Investors need to accept that we will be in a low interest rate environment for the foreseeable future and should not be tempted to take on more risk than they can safely tolerate.

"If you need an income now and you need the security that is provided by an annuity then you should buy an annuity," he adds.

But David Smith, director of financial planning at Tilney Bestinvest, thinks the fall in gilt yields means those planning to retire in the near future should consider delaying buying an annuity. He says soon-to-be retirees should look at using other retirement income options such as flexible income drawdown.

Flexible income drawdown allows retirees to draw income from their pension fund directly, taking as much or as little as they like while leaving the capital invested. Unlike an annuity, flexible drawdown gives individuals control over their pension pot as well as the ability to pass the fund on to a nominated beneficiary after they die. However as the capital remains invested, your income will ultimately be dictated by the performance of markets.

Despite this, and the inherent risk that your money could run out, flexible drawdown is a better option than buying an annuity with the low rates on offer, says Mr Smith.

"With a very clear signal [by the Governor of the Bank of England] that further interest rate cuts are on the cards, and possibly another round of quantitative easing (QE), UK gilt yields are now at an all-time low," he says. "As pension annuities are directly linked to gilt yields, the amount of income a retiree can secure from their pension has already fallen significantly and a further QE stimulus will only serve to compound the problem."

Figures show that the benchmark UK 10 year gilt yield fell from 1.37 per cent before the referendum vote to just 0.88 per cent at the time of writing. This sharp contraction has accelerated the long-term trend those drawing a retirement income have had to suffer. Before the financial crisis the UK 10-year gilt yield was 4.5 per cent, but years of ultra-low interest rates have eaten away at this.

Tom McPhail, head of retirement at Hargreaves Lansdown, says even before the vote to leave the EU gilt yields had been declining and, exacerbated by the vote for Brexit, have now fed into reduced annuity rates. His research has found a 65 year today is getting a lower annuity income rate than a 60 year old would have done just six months ago. And he expects more providers to cut their annuity rates over the next few weeks.

Mr McPhail suggests those considering buying an annuity have two options: either to do so as quickly as possible before annuity rates fall further or to delay buying one for some time yet.

"Annuity quotes are typically guaranteed for two to four weeks so investors who are worried about a further drop in rates should get their skates on. As always, make sure you shop around to get the best deal and to secure any enhanced rates you might be eligible for," he says. "If you're thinking of putting it off, that's fine but bear in mind that in 2008 we saw the start of QE and ever since then we've been having regular predictions of interest rates going up soon and that's repeatedly not happened. In fact, eight years later, they're going down further. So if you are going to wait, you're going to be waiting a while before things change."

Best lifetime annuity rates

Single life with level escalation (aged 65)

Joint Life -50% Spouse's Pension with level escalation (male aged 65, female aged 62)

Single life with RPI escalation (aged 65)

Joint Life -50% Spouse's Pension with RPI escalation (male aged 65, female aged 62)

Source: JLT Pension Decision as at 30 June 2016, showing guaranteed 5 year rates. Figures assume an annuity purchase price of £100,000 and are shown gross for non-smokers.

*Company has recently announced annuity rate cuts so these figures may change.

Retirement income options

If you want a guaranteed income for life, one way of supplementing the low annuity rates on offer is to employ a 'hybrid' approach - using an annuity to provide a base level of income to cover basic expenses and drawing money from other sources such as an individual savings account (Isa).

If you don't want to buy an annuity right now, Mr McPhail says you could delay your retirement a little, look to draw income from other resources such as your state pension or an Isa, or consider flexible income drawdown.

However he adds that if you are going to go down the flexible income drawdown route you need to be aware that we are likely to be heading for a period of sustained market volatility. "With the fluctuating asset values at the moment, everything is volatile and may well continue to be for some time to come, so be really mindful of the level of income you're drawing from your drawdown plan," he says. "I think a really good default position is to just draw the natural yield on your investments, so if you're looking at dividends - around 3-5 per cent. If you do that you're at least minimising the risk of eroding the capital."

He adds that the possibility inflation may rise is another consideration.

Andy James, head of retirement planning at Towry, also thinks we will face turbulent markets over the next few weeks and possibly longer. He warns against opting for flexible drawdown at the moment and suggests investors dip into a cash buffer, if they have one, to allow time for things to settle down.

"Market turbulence is not helpful when looking to take income from investments and certainly market falls in the short term can have a big effect on overall asset levels when combined with making withdrawals," he says. "I would therefore urge caution to those looking to make withdrawals at the present time and that they consider whether now is the right time to be doing this."

One retirement option which baby boomers are increasingly turning to in an attempt to offset rock-bottom interest and annuity rates is unlocking equity in their homes. Legal & General recently reported that sales of their lifetime mortgages - which allow people to tap into the equity in their properties - overtook individual annuity sales for the first time this year.

However, Mr McPhail suggests you should only access your housing equity to fund your retirement in your 70s and 80s.

He says: "Your life expectancy is still so high in your 60s that if you go into equity release you risk looking at 20, 30 or even more years of rolling up that debt, and as a consequence the terms you'll be offered by the insurance companies will not be particularly attractive."