Hopes the annuity market could rebound in 2013 have been crushed as it has emerged new "defensive measures" from giant defined benefit pension schemes are keeping rates low.
The UK's most generous pension plans – the 'gold-plated' defined benefit (DB) schemes of FTSE 100 companies, have collectively fortressed a trillion pounds of their workers’ money against investment losses, by buying and holding huge quantities of government index-linked bonds (gilts).
But the sheer size of these schemes means their movements have shaken the market and unintentionally chained annuity rates to the floor, effectively causing millions of pensioners with defined contribution schemes (DC) schemes to be locked into woefully measly deals in old age.
Speaking to Investors Chronicle, pensions experts said what the big pension schemes are doing is akin to "shoving their money under the mattress".
And they believe the schemes will continue to hoard gilts until the UK economy recovers, meaning retirees holding off annuitizing until rates rise could be in for a long, and miserable wait.
Russell Agius, partner at Aon Hewitt, said: "Our economy is making life tough for many large UK companies and they are too nervous to take risks with their pension schemes. It would take something extreme to persuade them to ditch gilts and buy riskier assets instead so this isn't about to change."
Annuity rates are currently at the lowest level they have been in two decades but in February they enjoyed a minor boost of around 3 per cent. Richard Williams, director at JLT Wealth Management, says the rise has been the result of a raft of smaller, “braver” pension schemes which have conversely been ditching gilts in favour of equities. But he said their actions are dwarfed by those of the FTSE 100 pensions giants, which are taking the exact opposite approach and having a repressive effect on annuity rates.
The difference between the pensions of retirees who have saved into DB schemes and DC schemes is starker than ever, according to Tom McPhail, head of pensions research at Hargreaves Lansdown. "The guaranteed benefits of savers with DB schemes is invaluable, and should not be underestimated." he said.
I'm close to retirement, what should I do?
Retirement experts haven't the foggiest idea when annuity rates will perk up. Over the short term, it's safe to say the outlook for annuities is looking bleak. But you should work on the assumption both the UK economy and annuity rates will eventually pick up – and if you can afford to hold off buying an annuity until prospects looks brighter, you should.
Mr McPhail said he would not consider buying an annuity at today's rates. "If you're in your 60s and you can afford the risk of not taking your annuity just yet, you should consider holding on until the market improves.
"You could also consider annuitizing a fraction of your pension pot and going into drawdown with the rest so you can have a bit of security but you don't have to commit to a bad rate."
Income Drawdown allows you to take income from your pension fund while the fund remains invested and continues to benefit from any fund growth. But there are set limits on how much you can withdraw. While these are also linked to gilt yields, a change in the rules from 26 March means they will be slightly more generous than what you could get from an annuity.
The downside of delaying annuity purchase is that you will miss out on the income that you would have received in the meantime from an annuity so this needs to be factored into your decision. You also take on the risk of leaving your pension pot invested in the stock market, so you need to be comfortable with this.
If you delay annuity purchase until a later date, you may find that if you suffer ill health in the meantime you could be eligible for a much higher income from an enhanced annuity. There are over 7,000 medical conditions that could entitle you to an enhanced annuity rate.
Why annuity rates have fallen off a cliff and can't get back up
■ DB pension schemes buying gilts
The UK's biggest pension schemes own hundreds of billions of pounds worth of gilts because they immunise them against sudden investment losses that could threaten the health of the entire scheme and threaten the safety of people's pensions.
But because these pension schemes own and invest such large amounts of money, their decisions can have wider impacts on the market, and in this case, their collective movement buying gilts has driven UK gilt yields down.
Because gilt yields are heavily factored in the calculation of annuity rates (the lower the yield the lower the rate), they contribute significantly to the measly nature of the annuitized incomes millions of DC pension savers are now getting lumped with.
■ BoE Monetary policy
The Bank of England's decision to unleash several rounds of extra money into our economy in an attempt to kick-start it has depressed gilt yields, and in turn, depressed annuity rates.
■ Market sentiment
The gloomy outlook for the UK's economy is having a negative impact on annuity rates.
■ We're living longer
Our life expectancy is dramatically increasing and we're now expected to live well into our 80s. But more years in retirement means insurers will have to pay out more to keep us going for the extra years – and this will only drive rates one way. Down.
| Annuity for 65 year old, level annuity, Guaranteed 5 years, £100,000 | ||
| May 03 | May 08 | March 13 |
| £7337 | £7723 | £5349 |
| Source: Hargreaves Lansdown | ||
