Buying an annuity can feel like riding a rollercoaster while blindfolded. Annuity take-up has fallen from 75 to 50 per cent in three years, with a million nervous retirees clinging to their retirement pots. Unfortunately there's no telling whether rates will go up or down, and whether staying on board will mean gains or pains. But at least if you weigh up the possible outcomes you can try to prepare for them, whichever way the market goes.
Annuity values are falling so fast it's not surprising that increasing numbers of people are either putting their retirement on hold or looking to other options. Shockingly, some experts are predicting that annuity rates could fall so low within the next year that they will give you significantly less income in exchange for your retirement pot than if you were to invest it in a bank account with a low interest rate. The reason why they predict that annuity rates will drop so steeply is the combined effect of further quantitative easing, incoming unisex rates (meaning men will be 5 per cent worse off) and European Solvency II legislation which may raise costs for insurance companies and lead them to cut their annuity rates.
At this level, the very best annuities could offer you would be the equivalent to the capital sum you have built up over your lifetime, if you live to your normal life expectancy. Malcolm Mclean, actuary at Barnett Waddingham, describes this as a "tragedy" and says that while annuities are worth a lot in terms of peace of mind and security, "it is wrong that the deal annuity holders are getting is poor and almost certainly less than they deserve".
Ros Altmann, director-general at Saga, says people buying annuities at current rates will already struggle to get their money back. "Annuity rates have fallen so much that a 65-year-old man with an average life expectancy will not receive his capital back when buying an annuity. I believe something urgently needs to be done to help people understand the risks," she says.
Until recently, anyone who said annuity rates were about to rise might have been laughed at, however fresh evidence has revealed a recovery could well be on the cards over the next few years (see Chris Dillow's recent article on annuity rates). Spencer Dale, a member of the Bank of England's Monetary Policy Committee, hinted at the reversal of quantitative easing in a speech last month, saying that "we need to sell a huge amount of gilts back to private sector investors", a move that would bolster annuity rates.
Quantitative easing is not the only reason why gilt yields are low, but Mr Dillow says the other reasons could fade away.
Although the effects of these changes would come too late for those who need to retire now or in the very near future, they are potentially good news for those who plan to collect their pension in five or 10 years, because they can expect much more generous annuity rates than those retiring now.
What should I do?
Is it worth putting off an annuity purchase and working for another five to 10 years? Perhaps, says Jamie Jenkins, head of wealth management at Standard Life. He says longevity is a bigger problem than the effect quantitative easing is having on gilt yields and annuity rates. "Quantitative easing comes and goes, and can be removed, but demographic trends are an inexorable cause of poor rates because annuity providers have to pay out for longer," he says. "But you can cancel this out by working longer because if you retire older, you'll get a better rate."
However, you'll have to wait significantly longer if you want a rate that will give you a significantly higher income. This is fine if you're in good health but if you really need to retire in the next few years you could actually lose out by waiting a year or two.
Data from annuity provider Just Retirement shows that if you delay collecting your annuity by one year, assuming your pot grows by 7 per cent that year it would take 12 years for the cumulative income from the deferred annuity purchase to catch up with the income you would have had if you bought it immediately. And if your fund grew by 0 per cent in that year, it would take until you were 105 to make up the difference.
