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20 June 2013 last updated
Annuity income and equities reduce as Fed plans to stop stimulus

Equity markets around the world have tumbled after Ben Bernanke of the US Federal Reserve signals the end of the stimulus programme known as Quantitative Easing sending annuity income 3% lower for people that remain invested before retiring.

The FTSE-100 index reduced 3.0% or 189 points to 6,159 and the Dow Jones index 353 points or 2.3% to end at 14,758 after falling 206 points yesterday.

The Federal Reserve intends to reduce the $85 billion a month programme of bond buying which has provided significant levels of liquidity to world equity markets during this year.

Most people remain invested until they purchase their annuities and have benefited from gains in the equity markets but are now experiencing the losses of a rapidly falling market.

Before buying a pension annuity people should consider moving their to a cash fund to avoid a sudden fall in equities as it can take up to four week to transfer to another provider.

 
Annuity income reduce as Fed to stop stimulus
  Equities and annuity income fall 3% as Federal Reserve plans to end its QE stimulus programme
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Income 10% lower when buying an annuity

Since 22 May when the index reached a high 6,840 it has reduced 681 points or almost 10% and this would the the same drop experienced by pension funds that track the FTSE-100 index. People retiring and taking their benefits would receive 10% less income from their fund than only one month ago.

For example, a person aged 65 buying an annuity on a single life, level basis with a fund of £100,000 could have received an income one month ago of £5,671 pa and this has reduced to £5,104 pa, a fall of £567 pa. The Office of National Statistics (ONS) would expect a male to live for 17.3 years and over his lifetime the reduced income would be £9,809. For females their life expectancy of 20.4 years reducing their income by £11,566.

Even with the significant falls in the past month equities are up significantly in the last two years. In October 2011 the index was at a recent low of 4,944 up 24.5% today at 6,159. This increase has offset the falls in gilt yields which have reduced UK annuity rates.

Annuity rates are based on the 15-year gilt yields and as a general rule a 10 basis point fall in yields would result in a 1.0% fall in annuity rates. Since July 2008 yields have reduced 19.8% and annuities are lower by 28.3% which indicates rates should increase shortly, however, equities are higher by 13.8%.

What is behind the Fed's timing of the announcement

The Federal Reserves new plan will see the $85 billion per month stimulus reduced by the end of 2013 and ending by mid 2014.

Originally the Federal Reserve has said that it will continue with the stimulus programme until US employment levels improved and although unemployment is falling this is largely due to a fall in the numbers looking for work.

As the US economy has not reached the unemployment target there is no reason to change the stimulus programme at the moment. On the other hand Ben Bernanke is concerned with falling inflation and wants to avoid deflation as in Japan and also another equity bubble.

Equities have been fueled by liquidity of $85 billion per month of Quantitative Easing driving markets higher and excessively so in Asia. The plan to announce the end of stimulus could be a strategy to shock investors avoiding a bubble in equities and bonds, allowing yields to rise in the government bond market.

The Fed does not need to adhere to its timetable to withdraw stimulus if unemployment does not increase or inflation does not rise but in the short term the excessive pricing in equities and the bond market have been reduced lowering the risk to economic recovery.

For people retiring their funds are smaller, however, the fall in the price of UK government bonds and gilts and rapidly rising yields will improve annuity rates in the short term. This means we could shortly see a small rebound in equities with improving annuities and July could be a better time to take retirement benefits.

News related stories:
UK annuity income 7.7% lower as US Federal Reserve considers stimulus
Pension annuity income 12.3% up as FTSE-100 index hits new high
Best annuity income 2.7% lower as UK equity markets tumble
Best annuity income and markets fall 1.6% after US Fed stimulus fears
Related internet links:
BBC - Global markets fall with end to US stimulus
Guardian - Sell-off in world markets after Fed end to QE
FT - Global sell-off raises turbulence fears
FT - Bernanke strikes to great effect
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