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Spend & Save

Act now on shrinking retirement incomes

Annuity rates continue to fall, leaving anyone close to retirement with an urgent decision to take

Gambling with retirement income may sound foolish, but it's what anyone taking a pension payment has to do. Payouts depend on the prevailing annuity rate, which means picking the wrong time to buy could leave you locked into a low rate.

But with annuity rates in freefall, delaying in the hope of getting a better rate could mean losing out on thousands. Three years ago, annuity rates were at almost 7 per cent. Now they've fallen to nearer 5.5 per cent, according to MGM Advantage, with further declines in prospect.

It means payouts for a 65-year-old with a £100,000 pension pot have fallen to £5,901 a year. With payouts partly determined by life expectancy, there could be some logic in delaying taking an annuity. Temptingly, a two-year delay could increase annual payouts in our example by £264.

But delaying would also mean giving up two years of income. That would be £11,802 in our example – which would take 44 years to recoup through the higher payout.

"With annuity rates at an all-time low it could be tempting to delay in the hope that rates will recover," said Andrew Tully of MGM Advantage. "But the signs indicate annuity rates will remain low in the short term."

The situation is likely to get worse after an EU gender directive comes into force in December outlawing the practice of offering different terms to men and women.

"The gender directive will equalise annuity rates for men and women which is likely to push male annuity rates down," warned Laith Khalaf of Hargreaves Lansdown. "Male rates could fall by 5 per cent or more; the Treasury suggests rates might fall by as much as 13 per cent."

But the best solution may not be to simply take an annuity now. One alternative is to use investments to yield an income and buy an annuity later, according to John Fletcher of Brewin Dolphin. "If investors opt to draw down their cash and include defensive stocks in their portfolio, they could enjoy returns which compare favourably with poor annuities – and keep their options open to buy an annuity if things change in the future."

Alan Higham at the specialist adviser Annuity Direct said such an approach was risky. "For those prepared to take some investment risk then over the next five to 10 years there is a decent chance of beating the annuity – but you could lose around 30 per cent if you were unlucky with market movements," he pointed out.

"Buying an annuity now is likely to be the right thing for those willing to accept inflation risk and want a guaranteed income with no risk."

But Wayne Slater of Spectrum Independent Financial Services said there were tax implications to consider. "If people rush to take an annuity now while they are still employed, they will pay tax on their annuity income at 20, 40 or 50 per cent," he pointed out. "They need to calculate whether they would be better off waiting until retirement when they could be paying the basic tax rate."

Other issues to bear in mind were relationship status, occupation, income, health, other debts, goals and attitude to risk, he said. "This is where taking advice can be vital."