News Archive - December 2008
Interest rates and annuity rates
04/12/2008Interest rates fell again today. The Bank of England base rate now stands at 2% which is its lowest level for over 50 years.
This latest fall is likely to lead to reductions in the rates that cash savers can expect from banks and building societies. But how will if affect annuity rates for people looking to take their personal pension benefits?
Annuity rates are determined by several factors. One important one is predicted mortality rates. Due to improvements in diet and medical science, we are likely to live longer now than we would have if we had been born 20 years earlier, and this trend seems likely to continue. The average remaining length of our life is taken into account by the actuaries when they decide how much they can afford to pay out as an income in exchange for a lump sum when an annuity is purchased. One important concept when looking at annuities is 'cross-subsidy'. Some people think that annuities represent poor value for money because if the annuitant is unlucky enough to die prematurely then their remaining 'pot' is lost to them. However, this factor is taken into account by the insurance company when calculating the annuity rates, because that 'surplus' cash is used to help fund those annuitants who live longer than average. One problem with the recent trend for 'enhanced' or' impaired' annuities is that it will drive down the annuity rates for those who do not have any health problems. This is because the people who purchase enhanced annuities (who by definition are likely to have a shorter average lifespan) will no longer be within the standard annuity 'pool' - this means that the average health of those buying a standard annuity should be better, so their life expectancy will be higher and thus the rates offered will be worse.(Get that? phew).
Another major determining factor of annuity rates is long-term gilt yields. Long gilts (those with around 15 years until their maturity date) are the investments used by annuity providers to guarantee the income from annuities.The current trend of falling interest rates acts to push down the yield on gilts meaning that annuity rates should fall in sympathy. All the drivers seem to be pointing to lower annuity rates in the future.
So what does this mean in practice? Well, if you are planning to buy an annuity within the next 12 months you may well get a better annuity rate now than if you delay. With no real end in sight to global stock market woes, and returns on cash likely to be poor in the short term, it might be a case of 'a bird in the hand is worth two in the bush'. By buying your annuity now you would at leasty benefit from a year's extra income.
Your Income Tax position will be relevant to the decision, so you should always seek professional advice from a pension specialist IFA like Mulberry Financial before making such a big decision.