19 June 2012 last updated

UK annuity rates lower with new QE as inflation falls

Inflation reducing close to the 2% level could mean more QE from the Bank of England at the expense of lower UK annuity rates for pensioners. The Office of National Statistics has said that inflation has reduced to it's lowest level in over two years with the Consumer Prices Index (CPI) falling to 2.8% in May down from 3% in April with the Retail Prices Index (RPI) also falling to 3.1% from 3.5% in April. The unexpected fall was due to lower energy and food prices and this increases the likelihood of the Bank of England introducing Quantitative Easing (QE). QE is the measure the BoE takes to purchase UK government bonds and gilts increasing the supply of money available to institutions and allowing them to purchase other assets. To date there has been £325 billion and to meet the Bank of England's CPI inflation target of 2% it is likely that QE will be extended by a further £50 billion.

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How QE will lower UK annuity rates

The side effect of Quantitative Easing is that by buying UK government bonds and gilts the price will increase and the yields decrease. As uk annuity rates are based on the 15-year gilt yields a fall in the yields will mean a fall in the income pensioners can receive from their pension funds. Since the recent financial crisis began in June 2011 pensioners have seen their income from annuities fall from £6,806 pa to £5,962 pa based on a fund of £100,000 for a male aged 65 with an annuity on a level basis. This is a significant fall in income of £844 pa or 12.4% in the past twelve months and is likely to reduce further this year.

A positive for people retiring in the next few months is that the US Federal Reserve could begin a new round of financial stimulus. For pensioners that remain invested in equities a new stimulus package usually results with increasing equity markets so there is a possibility that their funds will increase in value allowing them to maximise the income for the given uk annuity rates at the moment.

To counter falls in rates pensioners can consider alternatives to the conventional annuity such as with profits annuity using investment backed annuities that could pay up to 30% greater initial incomes. They would need to accept a slightly higher risk and have access to other pension income such as a personal or final salary pension.

If a pensioner has lifestyle medical conditions such as high blood pressure, Cholesterol, are a smoker or are overweight an enhanced annuity would offer higher income than the open market option standard rates. For more serious health conditions such as diabetes, heart conditions or cancer an impaired annuity would offer 40% higher incomes.

US stimulus see equities rise higher

Federal Reserve chairman Ben Bernanke and the Federal Open Markets Committee (FOMC) and likely to opt for Operation Twist, a smaller version of Quantitative Easing and involves selling medium term bonds to purchase longer term 10-year bonds. This is likely to reduce the interest rate on 10-year bonds with a general decrease across the board.

The Federal Reserve may purchase up to $200 billion of long term bonds with the expectation of stimulating the US economy to counter any repercussions from the Eurozone. The markets reacted positively to the news with the Dow Jones index up 95 points at 12,837 and the FTSE-100 up 95 at 5,586 with European markets also up between 1.2% to 2.6%. After recent falls in the 15-year gilt yields there has been an improvement with an increase of 6 basis points to 2.29%. Yields are still very low and it is likely that pension annuity rates will continue to reduce in the next two weeks.