Labour hits annuity rates

The decision to let the Bank set interest movements has had unforeseen results

Interest rates may be on the way up but annuity rates, which insurance companies pay to pensioners when they cash in their personal pensions, have fallen as a result of the shock decision to transfer responsibility for future interest rates away from the Chancellor of the Exchequer to a committee of experts at the Bank of England.

This is bad news for people coming up for retirement because the amounts they will receive for the rest of their lives are based on the rates current on the day the annuity is bought. Usually annuity rates rise and fall in line with interest rates but they are linked to the average yield on high coupon British government fixed interest stocks with around 15 years to run before they mature.

Normally, rising interest rates depress the price of fixed interest stocks and send the yields up. But this time round fixed interest stocks have risen and yields have fallen because the markets believe, rightly or wrongly, that the Bank of England will do a better job of holding down inflation and therefore long-term interest rates than the Chancellor would have done.

Annuities already being paid are not affected, but in some cases quoted payouts on new annuities have fallen by as much as five per cent in the past two weeks. Canada Life for example has lowered its rates three times in the last 10 days and a man of 65 buying an annuity from them with a lump sum of pounds 100,000 will now get pounds 10,657.92 a year compared with pounds 11,057.04 at the beginning of May.

At any one time rates vary from company to company as well as with the age, sex and therefore the life expectancy of the purchaser. A flat rate annuity fixed for life pays more initially than one linked to future inflation, one which pays a benefit to a surviving spouse, and one which guarantees to pay the first five years even if the purchaser dies. But the principles are the same.

Most annuity providers hold a quote for 14 days and the fall in rates has persuaded many people who received firm quotes before the election to go ahead with buying their annuities. Anyone who missed out on the old rates might be better advised now to wait a while and see if the rates rebound a little, says the Annuities Bureau, an independent specialist adviser. But it is equally possible that annuity rates will continue to fall over the long run as the threat of inflation fades.

Anyone deciding to retire on a personal pension is allowed to shop around for their annuities and need not buy them from the insurance company that provided the pension plan, although some companies, notably Equitable Life, will charge a penalty for transferring. Some pensioners have also taken advantage of a change in the rules in June 1996 that permits them to defer buying an annuity and instead to reinvest their pension lump sums in so-called income draw-down schemes.

Income draw-downs unfortunately pay less income than an equivalent annuity would buy. But unlike annuities they do allow pensioners to retain ownership of their capital and take advantage of rising stock and share prices and dividends and also to pass on their capital if they die.

Many have done well out of rising share prices and dividends, but as the graph shows the annuity they could now buy could well be 10 per cent less than they could have got 18 months ago. Their consolation will be that when they do buy an annuity, as they must before they reach 75 for a man or 70 for a woman, the annuity will be bigger because they are older and the payment dies with them.