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15 July 2012 last updated
Quantitative Easing - annuity rates and pensioner Income 6% lower

The use of Quantitative Easing by the Bank of England may result in a 60 basis point reduction in gilt yields followed by annuity rates decreasing by 6% during 2012.

The decrease of annuity rates due to Quantitative Easing would be in addition to the 12.4% decrease already experienced by pensioners since June 2011 due to the Eurozone crisis where investments have been moved to safe havens such as UK government gilts.

Gilt yields fall when demand for gilts increases and as prices increase it reduces the yield which means the return on those assets falls.

Annuity providers use 15-year gilts to secure the income for pensioners and as a general rule a 60 basis point reduction in gilt yields will result in a 6% decrease in annuity rates, although there may be a time lag before the changes are implemented by the providers.

Quantitative easing reduces annuities
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How quantitative easing reduces annuities

Quantitative Easing (QE) was introduced in March 2009 and had the effect of reducing
pension annuity rates by 6% during that year. QE was initiated as a result of the financial crisis requiring the Bank of England to inject money directly into the economy and they are doing this now to meet the Monetary Policy Committee (MPC) inflation target of 2%. The other method to achieve this target is by setting the bank Rate which is very low at 0.5% and therefore Quantitative Easing is the only way to meet the inflation target.

For December 2011 inflation, such as the Retail Price Index (RPI) fell from 4.8% to 4.2% and if this continues to fall at 0.6% per month it is likely to fall below the inflation target of 2%. Therefore the Bank of England's monetary policy committee (MPC) injected £50 billion (initially expected to be £75 billion) from February 2012 onwards and possibly up to £100 billion more during the year if required. Inflation by June 2012 reduced to 2.8% with a further £50 billion injected in July 2012 and brings the total assets purchases since QE began in 2009 to £375 billion.

The Bank of England intends to use Quantitative Easing to stimulate consumer spending and company investment. By buying government bonds or gilts the overall effect is to reduce the yield so encourage investors to switch from bonds or gilts to other financial assets such as company bonds which in turn will reduce the yield on these assets. This ultimately is expected to reduce the cost of borrowing for both the consumer and business and encourage spending due to the extra money in the economy which will help to increase inflation to meet the 2% target.

Quantitative Easing also has consequences for defined benefit or final salary schemes provided by employers as gilts are used to determine the future funding provisions for these schemes. As the yields decrease a company may find the final salary scheme deficit increases and therefore the company will at some stage need provide extra funds for the pension scheme rather than using these funds for other investments such as employing new people.

Improve annuity rates to counter QE effect

For anyone considering purchasing an annuity it is important to receive the maximum possible income so if pensioners have any medical conditions this could increase the income they can receive. Impaired annuity rates offer enhancements for over 1,500 conditions including people that smoke, high blood pressure or Cholesterol as well as heart conditions and cancers. The enhancements could increase income from 20% to 60% and this would make a significant difference to a pensioner’s quality of life by countering all the negative factors reducing annuity rates including Quantitative Easing.

The bank of England is using QE to benefit the wider economy but the side effect will be decreasing annuity rates for pensioners who are already suffering from lower incomes due to increasing inflation and Quantitative Easing will further reduce their buying power during their lifetime.

News related stories:
Annuity rates may lower if UK inflation fall leads to more QE
Annuity rates under threat as Bank of England injects £50 billion of QE
UK annuity rates lower with new QE as inflation falls
Standard annuity rates fall with Bank of England stimulus package
Retirement income from annuities may be hit with QE measures by BoE
UK pension annuity income may reduce with lower inflation and QE
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