Annuity rates have been on a downward trend for the last 25 years. Will they ever go back up again? We look at what drives annuity rates – and some other important factors to bear in mind when you’re thinking about what you might get from an annuity.
Two main factors influence annuity rates:
1. Life expectancy
2. Long-term interest rates
Life expectancy for both men and women has increased relentlessly over the last century, and more recently, the rate of improvement has quickened – for men in particular. This is a result of improved lifestyles, including reduced rates of smoking, and advancements in medical treatment.
Life expectancy for 65-year-old men has increased by about three years during this century. If an annuity income has to be paid for a longer period, then the amount paid each year will be less.
These improvements in life expectancy are to be welcomed, as they mean we are all living longer. But we all need to accept that retirement plans should recognise this improvement – 63 is the new 60 and 68 is the new 65!
Long-term interest rates are driven by the rate that the government borrows money at over periods of 15 years plus. Unlike interest rates for mortgages and deposit accounts, long-term interest rates tend to change in response to changing economic conditions, rather than changes in the Bank of England Base.
Inflation is one of the key things that influences long-term rates of interest. If inflation is expected to go up over the next few years, then it’s likely that long-term interest rates might start to rise.
A matter of supply and demand
Another factor affecting long-term interest rates is supply and demand. At the moment, investors are quite happy to lend money over long periods such as 20 or 30 years to the UK government as the UK is seen as a safe haven when the economic outlook is unclear. If investors begin to gain confidence in other investments such as shares, they are likely to start investing in those rather than lend to the governments of countries that are perceived to be ‘safe’. This would result in the demand falling, and borrowers such as the UK government would have to pay higher interest rates to attract investors.
Alternative types of annuity
By far the most common type of annuity is one that pays a fixed or increasing income for life. However, there are other types of annuity available:
These annuities allow you to set your initial income from within a range, and you choose how your annuity fund is invested. If your investments do well or you choose a low initial income, your future income could rise, but if your investments do badly or you choose a high level of initial income, your future income could fall.
With profits annuities
These are very similar to investment-linked annuities but you leave the investment choices to the managers of a with profits fund. Like investment-linked annuities, there is potential for your income to rise if the with profits fund does well or for your income to fall if it does badly.
Fixed or short-term annuities
These are annuities over shorter terms of usually 3, 5 or 10 years. They pay an income for the period chosen and then stop altogether. Some fixed-term annuities also pay a guaranteed maturity value. The rates of return from fixed-term annuities are quite low and you may be able to get a better return by investing your pension fund in fixed-term bank deposits.
Variable annuities are more like taking income withdrawals from an invested pension fund than a normal lifetime annuity. However, they do offer a guaranteed income for life. The guaranteed income usually starts out about 4% to 4.25% of your accumulated fund. This is about 30% less than the income you can get from a normal annuity, but with the hope that your invested pension fund will produce good enough returns to allow you to take more income in the future. The charges for these products are relatively high and they are only available via regulated financial advisers.
Selling your annuity
You may have heard that the government has announced people will be allowed to sell their annuities – but this won’t come into effect until 6 April 2017, at the earliest.
The Government is still consulting on how the market for selling annuities will work. This is what we know so far:
- Firms that want to buy your annuity will have to tell you how much your current annuity income is worth versus how much they are prepared to pay to buy your annuity from you. Expect the price they are prepared to pay to be quite a bit less than the value of your current annuity income.
- You will be required to take advice if your annuity is worth more than a certain amount. The Government hasn’t set the threshold yet.
- You can contact the Government’s Pension Wise service for free guidance.
- If your spouse or partner could benefit from your annuity in the event of your death, then they may be required to consent to the sale of your annuity.
In addition to these points, it’s worth mentioning that people in poor health will get back the least if they choose to sell their annuity, while those who are in good health will get the most.
The ability to sell your annuity won’t just be restricted to those who have already got one. Even people who take out an annuity after 6 April 2017 will be allowed to sell their annuity if they can find a buyer. However, we’d caution against buying an annuity with the aim of selling it later, as the price you get when you sell it second-hand will probably be a lot less than the price you paid originally. Therefore, if you are going to buy an annuity it should be done with the intention of keeping it for life.
We’ll provide an update on second-hand annuity market once the picture becomes clearer.