Whether we all understand the complexities of the Bank of England’s Quantitative Easing (QE) program or indeed the long term effects it will have the economic recovery and inflation, one thing seems beyond debate, it is reducing Annuity rates.
According to Saga QE has permanently reduced the incomes of one million retirees due to lower Annuity rates. Other figures show that since QE was first introduced in March 2009 Annuity rates have fallen by around 25%; you can check the Annuity rate applicable to you by using our online pension Annuity calculator.
But why does QE cause Annuity rates to fall? What can be done about it? Do you have any alternatives?
Read on to discover the answers.
First the economics, why is QE damaging Annuity rates?
In simple terms the Bank of England uses the money it creates to buy gilts from banks. The plan is that the banks will lend this money, getting this into the economy and encouraging growth; whether this actually happens is open to debate, but we’ll leave that for another day.
Back to Annuities.
When the Bank buys gilts it causes the price to rise, after all if an asset is in demand the owner of that asset can charge more for it. When the price of a gilts rise, the coupon, which is fixed, falls as a percentage of the capital value of the gilt.
Insurance companies use gilts to back the guaranteed income provided by their Annuity; therefore when the gilt yield falls so do Annuity rates.
Joanne Segars, chief executive of the National Association of Pension Funds, says: “Our priority has to be a stronger economy, so we understand the Bank’s case for more medicine. But this short-term stimulus is leaving pensioners and pension funds in long-term pain.”
She continued: “People retiring now will get a smaller pension than they expected. Retirees who get locked into a weak Annuity will find that the Bank’s money printing leaves them out of pocket for the rest of their lives.”
Despite the rate of inflation starting to slow the economic text books tell us that QE should cause inflation cause inflation to rise in the longer term.
If this is the case people who have bought an Annuity will receive a further blow; Annuities are generally arranged on a level basis meaning the income provided will be eroded by inflation.
No going back
The problem of falling Annuity rates is particularly acute for people retiring now. Once an Annuity has been bought it can never be changed, meaning that those purchasing now, when Annuity rates are low, will never benefit from any future increases in Annuity rates.
This means many would be retirees are caught in a catch 22, the income is needed now but they don’t want to lock into low Annuity rates for the rest of their life.
Alternative options to an Annuity
In many respects retirees are being hit by a perfect storm of falling Annuity rates, relatively high inflation and volatile investment performance over the past few years.
There is of course no guarantee that Annuity rates will rise in the future, there are other factors also pushing down and we’ve said before that we think it will be some years before we see any meaningful rise in rates.
So what options do you have if you need an income now but would like to avoid locking into low Annuity rates?
The traditional alternative has always been Income Drawdown; however this has also suffered as the maximum income available is also linked to gilt yields. Furthermore people looking to take an Annuity are generally risk averse whilst Income Drawdown usually involves taking an element of investment risk.
We wrote last month about Fixed Term Annuities nd how these may provide a partial solution, offering income now, with a Guaranteed Maturity Amount (GMA) in years to come. The GMA can then be used to buy an Annuity, when hopefully rates may have risen. You can read this article by clicking here.
The message is simple, there are options available if you need income now but don’t want to buy an Annuity.
What should you do?
There really are no easy answers.
Annuity rates have clearly fallen considerably since QE started and in our opinion will not rise significantly in the short term.
It’s therefore a case of balancing the need for income now against future movements in Annuity rates, whilst looking at other options, which might provide the income you need without tying you in to a low Annuity rate for the rest of your life.
Our team of Independent Financial Advisers in Nottingham are experienced in developing retirement income strategies for clients the length and breadth of the UK. If you are approaching retirement and would like advice on our options call one of our IFAs today on 0115 933 8433, alternatively enquire online or email email@example.com