24 May 2012 last updated

Annuity income at risk as gilt yields and markets fall sharply

The latest EU meeting to resolve the debt crisis sees gilt yields and markets fall and risks to pensioners when buying their annuity income. In anticipation of the European meeting both gilt yields and equities have reduced with the 15-year gilt yields down 9 basis points at 2.34%. For the month of July gilt yields have reduced from 2.67% to their current level which is a fall of 33 basis points. As a general rule this would translate to a 3.3% reduction in annuity rates at some point in the short term and providers have reduced their rates this month to reflect the falling gilt yields. Equity markets have also reduced with the FTSE-100 index falling by 136 or 2.5% to the lowest this month of 5,266. Since the beginning of the month the index has reduced by 546 points or 9.4% and the combination of falling equities and gilt yields creates a dangerous situation for people retiring at the moment.

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Pensioner annuity income lower

For pensioners that remain invested in equities and exposed to the decrease in the market coupled with annuity rates decreasing they can quickly find themselves with 10% less income from their annuities than they were expecting. Once an annuity is purchased it remains at that level for the lifetime of the annuitant unless a fixed term annuity is purchased in which case it would be possible to return to a lifetime annuity purchase at a later date.

An alternative would be a with profits annuity or investment backed annuity that can offer up to 30% higher initial incomes than the standard open market option. This is a higher risk annuity as the fund is invested with a smoothed income rather than reflecting equity markets so pensioners may be suitable where there are other pension income such as a final salary pension or more than one personal pension fund.

To make the most of a pension fund if a pensioner suffers from a lifestyle medical condition such as high blood pressure, Cholesterol, are a smoker or are overweight an enhanced annuity could offer more income. For other health conditions such as diabetes, heart conditions or cancer an impaired annuity could pay 40% higher incomes than the highest conventional annuity.

Equity markets are concerned that Greece could leave the Euro and if this happens the cost of the exit could be $1 trillion according to the governor of the Bank of England, Sir Mervyn King. In Europe markets in Italy are down 3.7% and in Spain down 3.3% with France lower by about 2.0% and Germany down 2.4%.

Eurozone struggles with sovereign debt

The current discussion is for the issue of pan-European bonds to allow struggling countries such as Spain and Italy to borrow at a lower cost. However, this would be a form of debt pooling by European countries and Germany will not consider this option as the burden will be shifted to Germany if the other European countries default. In terms of borrowing, Spain's 10-year borrowing cost is at 6.2%, Italy is at 5.75% and Germany is 1.4% so this is a significant difference.

The problems in the Eurozone have a long way to go although it seems any solutions the European leaders can develop will only result in a short term rebound before investors' concerns return and threaten the income pensioners can realise from their pension funds with lower equities, gilt yields and pension annuity rates.