Annuity rates are looking bleak following the Bank of England’s reduction in interest rates. The move to cut interest rates to 0.25% has negatively affected annuity rates, already at record lows, as they are based on government bond yields or gilts. People either ‘at’ or’ approaching’ retirement, and who want to avoid the investment risk and charges associated with keeping a pension portfolio invested in the markets through drawdown, may have been looking to buy an annuity to provide a guaranteed income for life. These people have been badly hit by the BoE decision and the guaranteed income they were counting on might now not meet all their needs.
One possible solution might be to increase contributions ahead of retirement to offset the reduction in annuity rates. This could prove quite a costly exercise and, worse, may not be an option because of the unhelpful recent reduction in the lifetime allowance (LTA). So on one hand we have the Bank of England reducing the amount they will receive, and on the other the Treasury and DWP have limited the amount they can save. Hardly seems fair, does it?
The LTA, the total limit people can save into a pension fund, was reduced to £1m in April this year. Tilney financial planner Gary Smith said at present, a £1m purchase of a joint life annuity for a 65-year-old, increasing by RPI inflation will currently provide a £25,120 annual income or £18,843 if the saver takes their 25% tax-free cash. This was well below the average UK salary, Smith added. He urged the government to consider reversing the LTA cut or scrapping the limit completely to make it easier for people to save towards a decent retirement income.
Smith said the outlook for annuity rates was "bleak" as the BoE signalled the potential for future rate cuts. He explained: "Annuity rates were already negatively being impacted by market jitters, including the uncertainty created by the vote for Brexit, as nervous investors have seen gilts as a safe haven. As gilt prices have rallied, this has, in turn, decimated gilt yields, with 10-year gilts now yielding 0.55% at a time when inflation is expected to rise. I have already experienced a reduction of 5.4% in the annuity rate quoted for a client, and this reduction occurred in a short period between 6 July and 9 August . . . with little expectation of an increase in interest rates in the short term, the future for annuities seems very gloomy indeed."
To put a human face to this unfortunate situation, Ruth Lythe writing in MoneyMail says: “the Bank of England's bid to boost the economy has left pensioners with incomes of just £6 a day after a lifetime of saving. Four of Britain's biggest insurers have slashed pension payouts since official interest rates were halved from 0.5 per cent to 0.25 per cent and billions of pounds was pumped into the economy last week. Aviva, Legal & General, LV= and Just Retirement have all axed the top deals for new customers who want to turn their pensions into an income for life, and are offering married couples a paltry inflation-proofed income of £2,256 a year at most for every £100,000 in their pots. That's just £6.18 a day — barely enough to treat the grandchildren to ice creams at the seaside or pay for fish and chips on the pier.”
Even allowing for the slightly sensational aspect of this (many people will have multiples of £100,000 in their pension pot), it highlights the reality.
A ray of hope?
Many retirees who are staring down the barrel of reduced pension income might be thinking of releasing equity from property to bolster their income. According to Andrea Rozario, chief corporate officer at Bower Retirement Services, writing in Retirement Planner, the effect of Brexit on house prices, and thus on equity release, might not be as bad as the doom-merchants are suggesting.
“Many are comparing the aftermath of Brexit with the recession of 2008, and millions could well be concerned that their biggest and most important asset – their home – may suddenly dip in value. These concerns are valid, but it’s essential to understand what has happened to house prices throughout history to have a reasonable understanding of how they may fare moving forward.”
“Of course, there can be no guarantees, house prices can rise or fall like any other market, but one thing is certain, property has been one of the safest and most lucrative investments in the country over the past 40 to 50 years. Even when we have experienced recession, including catastrophic recessions like 2008, house prices have not dropped dramatically. What’s more, as a home is generally a long term investment, riding out the odd blip is par for the course for every homeowner. Retirees, as well as anyone else currently on the ladder, should therefore take great solace in the fact that house prices in this country have been historically resilient and rebound incredibly quickly.”
There will be a careful balancing act to be done for everyone at or approaching retirement, in light of recent changes. There is, as we have said previously, a clearly perceived need for people to have access to financial advice to guide them through these minefields on their way to a comfortable retirement. Let us hope that Financial Advisors take advantage of this opportunity to make their services attractive and approachable.