Annuity rate dive will hit millions of retirees short

The fall in gilt yields will reduce pension incomes, so it's more important than ever to choose the right product. By Julian Knight

Britain can borrow at the lowest cost for 50 years. This is remarkable considering the country is running its biggest ever fiscal deficit. It seems that in the West, racked by debt, Britain has emerged as something of a haven, at least for the time being. This is good news for government finances, but not for savers coming up to the time that they turn their pension pot into an annuity, an income for life.

In fact, according to figures produced by independent annuity experts Better Retirement Group, the average yield on a UK Treasury gilt has fallen in the past fortnight from 3.9 per cent to 3.5 per cent. These gilt rates are crucial to the amount of income – an annuity – an individual's pension pot can buy. Any sustained fall in gilt rates will inevitably mean that annuity rates are cut as well. Billy Burrows of the Better Retirement Group reckons that this is already happening.

"The main reason for the sudden reduction in yields is the flight to quality resulting from the European and US debt problems," he said. "As the price of gilts rises, the yields fall. In fact, UK gilt yields are at their lowest level for many years. It won't take long for this to feed through to annuity rates and what insurers pay. For example, Aviva has cut its annuity rates and the drop is about £ 70 a year for a £100,000 pension pot. Although the cuts in income are small, about 1 per cent, it shows the trend is downwards."

Of course, over the full term of an annuity contract – which could be as long as 40 years – even a small fall in annual income could cost thousands of pounds.

This is a point echoed by Tom McPhail from independent financial advice firm Hargreaves Lansdown. "The low level of gilts is almost unprecedented and the resulting annuity rate fall is significant," he said.

According to Mr Burrows, even just a 0.5 per cent fall in gilt yields can lead to a 5 per cent dip in the annuity a pension pot can buy.

Generally, when pension savers reaches retirement, they are offered the opportunity to convert their pension pot into an annuity. Their insurer will write to them with a quote but each individual has the right to reject this offer and search the market for a better annuity rate. This is called the open market option. But quotes are often valid for only 14 days; with the rapid decline in gilt yields, annuity experts are urging people at the point of retirement to act quickly.

"The point is that anybody considering an annuity in the next few weeks or months should not delay. Anybody thinking of an annuity next year should probably wait and see what happens with the eurozone, US and the UK," Mr Burrows said.

Experts say it is essential for people not to only shop around for the best rate but also take advantage of the enhanced annuities that are offered to people with medical conditions which may shorten their lives.

"Our research shows that far too few people take advantage of enhanced annuities which can mean a bigger income even with medical conditions as common as high blood pressure or diabetes," said Stephen Lowe, the group external affairs director at Just Retirement. "One in five people has one an enhanced annuity but up to 60 per cent could qualify. The big insurance companies don't tell people about them, while some advisers don't ask the right questions to establish if an enhanced annuity is applicable."

Last week, the Government said that one in three children born this year would live to be 100. Increased longevity makes it even more important for pension savers to consider their annuity options, and in particular to protect their annuity against inflation by buying an index-linked product rather than fixed.

"With retirement income needed to cover 20 to 40 years rather than just five to 15, it is vital that the effects of inflation are assessed," said David Marlow, the development manager at Creative Benefits. "Many retirees opt for a fixed-rate guaranteed annuity, as this is the only option that they are aware of."

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