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15 August 2014 last updated
Best annuity rates could fall 3% as gilt yield market remains low

The best annuity rates are under threat as the 15-year gilt yields fall to a new low for the year of 2.82% the lowest for twelve months with further decreases in equity markets impacting annuity income.

Annuity rates are primarily based on the 15-year gilt yields which have been falling in recent weeks after reaching a high of 3.47% in January fell to 3.05% by the end of July and are now at 2.82%.

So far this month yields have reduced by 23 basis points and as a general rule this will result in a 2.3% decrease in annuity rates from the providers although this has not been applied.

In addition equity markets have also decreased and for those that remain invested before buying their annuity this can result in a lower level of income.

Equity markets were at 6,821 and are lower by 132 or 1.9%. For a pension portfolio that reflects the FTSE-100 index will mean the fund value will also have reduced by this amount in the last month.

 
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Yields suggest fall in annuities expected

In July standard annuities decreased slightly by 0.08% while yields reduced by 0.90% suggesting rates could fall by a further 0.82%.

With recent lower yields it would suggest that annuity rates could now reduce by 3.12%. Our benchmark example below shows how the rate is at the lower end compared to any of the past 7 months, even though gilt yields higher.

  Benchmark annuity rates and gilt yields
  Feb Mar Apr May Jun Jul Aug
Rate £6,037 £6,093 £6,080 £6,078 £6,143 £6,135 £6,135
Yield 3.17% 3.17% 3.16% 3.06% 3.14% 3.05% 2.82%


For our benchmark example of a person with £100,000 buying an annuity on a single life, level basis a 3.12% reduction would see rates £191 lower at £5,944 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 £3,304 more over his lifetime. For a female she can expected to live for 20.4 years increasing her income by £3,896.

The recent fall in the FTSE-100 index would also have an impact on the annuity income. A fund of £100,000 in the middle of July invested to tracks this index would now have reduced to a value of £98,100.

The combination of falling rates and markets can have a significant effect on income. Based on the above example this would have resulted in an income from an annuity of £5,831 pa or a decrease of £304 pa or 4.95%.

Other factors impacting yields

In the US the Federal Reserve continues to reduce the stimulus package which was at $85 billion in December 2013. It started to reduce this by $10 billion in January 2014 and the latest $10 billion reduction in July reduces this to $25 billion.

Markets are more focused on interest rate rises and the Bank of England has moved away from the prospect of a rise at the end of 2014 due to recent data of slow wage growth which is still lower than inflation.

Governor of the Bank Mark Carney has indicated that wage inflation is critical to the date interest rates can rise and therefore this is now expected to occur from the spring of 2015. An interest rate rise would directly impact gilt yields causing yields to increase followed by annuity rates.

With many negative factors acting to reduce yields and reducing rates there are options that can be considered to delay buying an annuity until rates improve.

It is possible to take your tax free lump using a fixed term annuity for one year allowing time to benefit the new pension rules and improving rates giving an income and a guaranteed maturity amount at the end of the term.

An alternative would be pension drawdown now available even for smaller funds of £30,000 to £100,000 and this option would allow greater income flexibility than the fixed term plan.

News related stories:
Enhanced annuities fall as Ukraine crisis sends yields to new low
Pension annuity income threat as FTSE and yields fall on latest data
Enhanced annuities fall as Bank of England resist interest rate rise
Related internet links:
Guardian - Bank of England backs away from higher interest rates
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