When it comes to buying a pension annuity, there is more to shopping around than just the price, you also need to get the right type of pension annuity. Pension annuities have long been the bedrock for retirement incomes, but now that pension annuity rates have fallen to an all-time low – quite a drastic comment with disastrous results - we have reached a point where it is time to review the role pension annuities play in retirement planning. It is perhaps time to suggest that those individuals with above average sized pension funds consider some of the newly introduced flexible annuity options.
But why are pension annuity rates so low at the moment? These rates have been falling since 1990. In that year the annuity rate for a 65-year-old male was over 15.5%, whereas now it is less than 6.5%, a massive fall. In 1990 the yield on 15-year gilts was over 11%, whereas today it is around 3%. Inflation back then was in excess of 10%, today it is about 5%.
In August last year pension annuity rates actually hit their lowest point since 1990 and this was made even worse because falling rates combined with falling equity prices to give people retiring something of a raw deal – low rates and reducing pension funds. In August, 2011, annuity income dropped by over £300 a year, or around 5%, and, during the same month, the UK stockmarket fell by a significant 9%.
Pension savers are being told to shop around using their open market option for the best annuity rates which some are doing with much enthusiasm. However, the problem seems to be that most only know how to shop around for price – not quality. Remember, all clients are not the same – they have different requirements – and most people can expect their pension annuities to be in payment for 20 years or more, and that’s a long time.
There are basically two reasons why those with smaller pension funds should have other types of pension annuities. They might want to offset the future effects of ongoing inflation and they might want the flexibility to benefit from higher annuity rates in the future, perhaps if their health deteriorates over time. Those individuals with larger pension funds can afford to take more of a risk and often have more complicated retirement planning goals which means that there is a case for considering alternative pension drawdown options.
How can those with ‘medium size’ pension funds get a better deal from their pension annuities? They could take more risk with their retirement income in the expectation of getting a higher annuity income in the future – perhaps with fixed-term pension annuities, investment-linked annuities, and potentially income drawdown. Annuities should not just be seen simply as a commodity as retirees should consider how they can best meet their retirement goals and take into account how long they might live, what will happen to ongoing inflation, what will happen to future equity returns, and their state of health. It is only when all these factors are taken into account that the right retirement solution can be found, and this might not be with a pension annuity.
