Money: Factors affecting Annuity rates

Factors affecting annuity rates

Even the best annuity rates in the market have decreased by almost 4% in the last 3 months putting further pressure on the retirement income of those about to retire. There are a number of factors that are placing pressure on annuity rates, so I have tried to explain a few key influencing factors – without getting too technical – hopefully!

1) The Eurozone Factor

The current turmoil within the European Union around the credit worthiness of some countries has meant that some country’s Governments are struggling to attract investors at normal returns. This is because the risk of a default on the loan could be high.

As the risk of the UK Government defaulting on a loan is considered to be low and therefore a relatively safe investment. The sale of UK Government Gilts is currently often oversubscribed which pushes the price up and therefore reduces the rate of return because investors believe that the risk of default is a lot lower, and therefore investors are unlikely to lose their money.

10 year Government Yields (return)

UK 2.17%
Greece 34.41%
Ireland 7.58%
Italy 6.09%
Portugal 14.57%

Source: Financial Times 23-01-12

I am going to try and explain this further, using an example outside of the world of finance and apply it to golf (so please bear with me).

Imagine you are on the 18th hole, ok let’s make it The Open, you are playing your fiercest rival and it’s all level. They produced a great drive and are on the fairway. However, you on the other hand have hit the distance but are in the deep rough, and in front of you are some big bunkers.

You have two options:

Option A – Have the certainty of making a good shot and lay it up close to the pin, but as a result you will come second. You pick up a cheque for second place but it is a smaller cheque than if you’d won (Investing in a stable low risk Gilt)

Option B – Going for the winning shot – if you make the shot you win and collect the big winners cheque, but if you end up in the bunker you lose your cheque, but could still get a percentage of it back as long as you get out of the bunker. (Investing in a riskier Governments Gilt – potentially higher returns but at the risk of receiving only a proportion of what you invested back, or worst case nothing back.

So what impact does this have on your annuity or pension annuity?

As Gilt yields are one of the factors that providers use when they are calculating their annuity rate. Annuity providers need to assess the level of return that they will be able to generate over the period that they are paying your annuity, when Gilt returns are low they can only secure low returns. This means that there isn’t as much investment return to share with you as the annuity holder which in turn reduces the annuity level that you will receive.

2) Quantitative Easing (aka – Bank of England printing money)

The Bank of England sometimes ‘prints’ more money which they can then lend to the Government in with the view to getting more money flowing in the economy. When they lend the printed money to the Government they buy – you guessed it – Government Gilts, this in turn increases the demand for Gilts, which puts further pressure on the rate of return or Gilt yield, and often reduces the yield further. The BBC has produced this Q&A on Quantitative Easing (QE).

A reduction in Annuity rates was seen in 2009 after the first round of QE. Therefore, there is the potential that if further QE occurs then there could be further falls in annuity rates which according to some could be as early as next month, RBS economist Ross Walker joined other city analysts saying “our forecast is for more QE in February.”

Making the decision of when to retire more tricky

Some individuals are fortunate enough to be able to choose when they retire, however, in the current climate is it better to delay retirement or at least purchasing an annuity? There is no clear answer, as this could depend on your own individual circumstances. If you are unsure, it is best to speak to an independent financial adviser

However, no independent financial adviser can tell you whether annuity rates are going to increase or decrease over the next 12 months, even if they did fall by another 4% these loses can often easily be reversed by shopping around for you annuity rates as standard annuity rates can vary by as much as 20% between providers and the difference between a standard annuity and an enhanced annuity can be as much as 40%.

So while there may have been small decreases even in the best annuity rates overall, this doesn’t need to necessarily change, or mean you have to delay your plans for retirement. To receive a free personalised annuity quote comparing the whole annuity market visit TheRetirementCentre.com

Previous Blogs:

2012 – New Equity Release Market?
Pensions and Retirement in the 1970s
Top 10 New Years Resolutions
Pension and Retirement in the 1960s

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