Anyone approaching or reaching retirement in 2008 stands to be one of the few winners of the credit crunch. While rising interest rates, soaring inflation and a drought in the borrowing markets have all been bad news for most of us, one positive side effect is that annuity rates are now at a six-year high.
Annuities are products offered by life insurers that convert your pension fund into an annual income when you retire. So, for example, a man retiring at age 65 today, with a pension pot of £100,000, might be offered an annual income of around £7,800 a year for the rest of his life, in return for handing over his entire pension fund to an insurer. Two years ago, the best he might have been offered would have been at least £400 or £500 a year less – an income he'd then have been stuck with for the rest of his life.
Until the start of the credit crunch, annuity rates had been in sharp decline for almost two decades, falling by about 50 per cent, driven downwards by a combination of low interest rates, low inflation and increasing life expectancies. But although the slight rally in recent months is great news for people retiring now, it is unlikely to represent a reversal in the long-term trend. As a result, anyone wanting to buy an annuity in the near future should think about taking advantage of the good rates while they last.
Over the last few weeks, there have already been some indications that annuity rates may be on their way back down again, as some of the larger providers have cut back their offers. Although the headline rate of inflation is currently high, many economists believe that it will fall right back over the coming year – one factor that will help to push annuity rates down.
Furthermore, with economic growth having ground to a halt during the second quarter of 2008, it is expected that the Bank of England will cut interest rates over the next 12 months, which will also have a negative effect on annuity rates.
Nevertheless, today's high rates are by no means the only consideration when planning how to manage your retirement income. Although it's compulsory to buy an annuity with anything that's left in your pension by the time you reach 75, it is still possible to start drawing from your pension before then without buying an annuity.
"You've got to look at your own risks and needs," says Tom McPhail, the head of pensions research at Hargreaves Lansdown. "Are you willing to take on the danger of equity market exposure after retirement? If not, perhaps you'd be better buying an annuity with all of your pension fund now. And are you willing to take a risk with inflation? If not, maybe you need to buy some protection."
Most insurance companies will offer you the chance to buy an annuity where the income increases each year, to help your money keep pace with inflation. However, your starting rate of income will be much less.
Although it's possible to get annuities that are linked to the Retail Prices Index, McPhail points out that you will get a much better rate if you're willing simply to accept that your income increases by a fixed amount each year, say 3 per cent. At the moment, a 65-year-old man with a £100,000 pension pot would receive a starting income of £4,712 if he insisted on it rising by RPI each year. But he'd get £5,703 if he settled for a flat annual rise of 3 per cent.
If you're willing to take some equity risk, McPhail suggests you could buy an annuity at today's rates with half your pension pot, while putting the remainder into a so-called "income drawdown" plan, which could remain invested in a medium-risk equity fund, such as an equity income unit trust.
If you do decide to buy an annuity now, it's crucial that you shop around. The difference between the best and worst rates offered by different insurers can be 10 or 15 per cent – which on a big pension pot will be a difference of thousands of pounds every year, for life.
McPhail adds that it's also important to consider whether you have any health conditions that may shorten your life expectancy, as this could further increase the amount of income you're offered. If you're overweight, you smoke, or you've got diabetes, you may be able to get an uplift of as much as 60 per cent from companies such as Partnership Assurance and Just Retirement.
Living in the wrong part of town could also see you qualify for a small uplift. Prudential, Norwich Union and Legal & General all offer "postcode annuities" now, where they pay out more to people who live in certain areas of the country. Residents of Glasgow, for example, are statistically likely to die younger than people living elsewhere, so will get a better rate.
Finally, it's well worth taking financial advice before rushing into any decisions. When it comes to buying an annuity, the advice won't cost you anything, as the price of an annuity includes a commission for advice, whether you take it or not. If you want to buy direct, it's worth using services such as Hargreaves Lansdown's annuity supermarket (http:// www.h-l.co.uk/ pensions_and_retirement/annuities.hl), or getting an idea of annuity rates from the Financial Services Authority's comparison tables at www.fsa.gov.uk/table.
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