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1 May 2015 last updated

Best annuities could rise as Federal Reserve delays raising rates

UK best annuities could increase as gilt yields bounce back following the US Federal Reserve delay in raising interest rates following weaker than expected manufacturing and employment data.

Annuity rates are primarily based on the 15-year gilt yields which have seen a 26 basis point rise in recent weeks. As a general rule this would result in a 2.6% rise in annuities should the yields remain at the current level of 2.22%.

Gilt yields reduced to an all time low of 1.68% on 30 January after the European Central Bank announced the start of their Quantitative Easing with €1.1 trillion for the Eurozone until September 2016.

After the Fed gave no indication of when they would increase interest rates investors dumped US Treasury notes, German Bunds and UK gilts sending the price down and yields up. The reason was less gloomy data from Europe, failure of a German five-year debt auction and over supply of US bonds. Interest rates are expected to rise in December.

Best annuities to rise on Fed delays
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Annuities could see a 2.6% increase

Standard annuity rates reached an all time low in January 2013 and our benchmark example at that time for a person aged 65 with a fund of £100,000 buying a single life, level annuity was £5,373 pa.

  Benchmark annuity rates and gilt yields
  Nov Dec Jan Feb Mar Apr May
Rate £5,900 £5,755 £5,506 £5,494 £5,485 £5,507 £5,507
Yield 2.35% 2.15% 1.68% 2.15% 1.96% 2.18% 2.20%

Since the all time low annuity rates recovered by November 2013 to an the income of £6,196 pa as the Federal Reserve announced it would end stimulus package only to reduce again when the European Central Bank (ECB) announced quantitative easing in January.

Annuities have remained low since then even though yields have improved from the all time low level for 15-year gilt yields of 1.68%.

If rates increase by 2.6%, for our benchmark example the income of £5,507 pa would increase by £143 pa to £5,650 pa. In terms of lifetime income, the Office of National Statistics (ONS) would expect a male to live for 17.3 years and he will have £2,473 more over his lifetime. For a female she can expected to live for 20.4 years increasing her income by £2,917.

Fed in a bind over low European yields

Warren Buffett, the chairman of Berkshire Hathaway, has said the US Federal Reserve is caught in a bind. The ECB has introduced quantitative easing sending European yields to an all time low creating a huge yield gap between the US and the EU.

This has resulted in funds flowing into the US debt markets and sending the dollar higher. To a certain extent the Fed cannot act by increasing interest rates as it would simple compound the problem.

As a result of a slack labour market where unemployment appears low at 5.5% but wages struggle to rise, the Fed will be unable to increase interest rates possibly at any time this year.

News related stories:
UK annuities could rise as 15-year gilt yields makes a strong recovery
Pension annuity rates to reduce as ECB starts €1.1 trillion stimulus
Annuities to fall when ECB €1 trillion stimulus plan starts
Pension annuities remain unchanged as Fed stimulus is ended
UK annuity rates unchanged by Fed tapering but interest rates will bite
Related internet links:
Telegraph - New doubts of Fed tightening
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