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13 December 2012 last updated
Pension annuity rates may increase with UK loss of AAA rating

Fitch and Standard & Poor's rating agencies have warned the UK risked losing it's AAA rating due to debt credibility and this would increase the cost borrowing indirectly helping pension annuity rates to increase over time.

UK public debt as a percentage of gross domestic product (GDP) is likely to continue rising until 2015 due to weak growth before the Government can start to see a decrease a year later than Chancellor George Osborne was expecting.

Standard & Poor's (S&P) has placed the UK on a negative outlook with a one in three chance of a downgrade in the next two years with a similar warning from Fitch last week.

The result of a downgrade would be to increase the cost of borrowing as the UK would be seen as a higher risk to investors which would mean it becomes more difficult for the Government to reduce the deficit.

Loss of credit rating to help annuity rates
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Annuity rates likely to increase with lower rating

The good news for pensioners is that the price of gilt yields would fall resulting with an increase in yields. Pension annuity rates are based on the 15-year gilt yields which currently stand at 2.35%. In June 2011 yields were at 3.98% and have reduced 165 basis points. As a rough guide this would translate to a fall in annuities of 16.5% and they have actually reduced by 17.8% based on our benchmark example.

The fall in gilt yields has been due to a combination of factors including Quantitative Easing (QE) where the Government has printed £375 billion and purchased gilts and the debt crisis in the Eurozone where investors purchase UK gilts as a safe haven to escape the regular threats of sovereign bond defaults from countries such as Greece, portugal, Spain and Italy.

A downgrade of the UK's AAA credit rating would mean some funds may not be able to hold gilts in their portfolio if AAA is specified and investors may select to use bonds of other countries such as Germany, Canada or France. coupled to this would be the Bank of England (BoE) change in direction not to continue with QE which has seen gilt yields rise recently. This could be due to investors selling their positions if they believe the BoE will not be buying gilts in the future to drive the price higher.

Pensioners pay for UK economic downturn

Pensioners have been paying for the economic downturn by having to accept low pension annuity rates. Since annuities reached a recent high in July 2008 when the financial crisis was unraveling, annuities have reduced by 29.2%. This means a male aged 65 with a fund of £100,000 could purchase an income on a single life and level for £7,908 pa in 2008 and this has reduced to £5,594 pa today or £2,314 pa less a year. The Office of National Statistics (ONS) would expect him to live for 17.6 years so over his lifetime he would receive £40,726 less from the pension annuity than four years ago.

In 2008 he could expect to receive £139,180 over his lifetime and now if he lives to the average of 17.6 years he will receive only £98,454, not receive his original fund back from the annuity.

News related stories:
Retirement annuities unlikely to gain after UK loses AAA rating
Annuity Income falls as S&P downgrades Spain's credit rating
UK annuities would be lower if Eurozone AAA rating downgraded
Related internet links:
BBC - UK warned over AAA credit rating
Guardian - UK loss of AAA inevitable
Telegraph - S&P threatens UK rating downgrade
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