Potential yields from pension pots have risen, but talk of an upward trend is premature
There was a sliver of good news this week for older people: retirement incomes for new pensioners have risen for the first time in almost a year. But this rise in annuity rates should be seen as a short-term boost rather than the beginning of a long-term upturn, advisers warn.
Annuity rates determine how much pension income someone will get from the cash they have built up in a money purchase workplace scheme or personal pension plan – and these rates have been falling for years.
However, the latest figures from specialist firm the Annuity Bureau show that Aviva is paying an annual income of £5,103 to a 60-year-old with a £100,000 pension pot who opts for a conventional “level” annuity. That is an increase of just over 3%, or £154 a year, on the company’s February rate.
Inflation-linked annuities have also risen this month, with Legal & General offering £2,882 to someone aged 60 using their £100,000 pot to buy an annuity linked to the retail prices index (RPI). That is an increase of £78 on its February rate.
Annuity rates for smokers, which are normally higher than those for to non-smokers, have also risen across the board, with Just Retirement now paying out £5,937 per year to a 60-year-old with a £100,000 pot. That is almost 10% more than the company was offering at the beginning of January, and over a 20-year retirement that would add up to an extra £10,760 of income.
But these increases, while welcome, should not be taken as a sign of an upward trend. Annuity rates have been in long-term decline since the early 1990s, mainly because of increasing longevity – the longer people are expected to live, the lower the annual pension offered. Standard annuity rates have gone down by around 30% over the past four years and have halved since 1994.
But every now and again, changes to gilt yields give annuity rates a temporary boost. “This has happened in February, with most providers increasing their rates,” says Annuity Bureau director Richard Williams. “However, this could be short-lived as gilt yields are down almost 10% off their high point in the middle of last month.”
And this month’s lift is less cheering when compared with the £5,520 annual income Aviva was paying out 12 months ago to a 60-year-old with a £100,000 pot who opted for a level annuity. In other words, someone buying their annuity in March 2012 was getting 8% more than today – only a year later.
“One swallow does not make a spring,” agrees Tom McPhail, head of pensions research at independent financial adviser Hargreaves Lansdown. “While some providers have made modest rate increases, there is not sufficient evidence yet that we are seeing any long-term reversal in annuity rates.”
Annuity rates have equalised for men and women since the EU gender directive came into effect last December. This bans companies from taking gender into account when calculating the cost of insurance premiums. Where women used to get lower annuity rates than men because they have longer life expectancy, they will now receive the same pension income when purchasing equivalent annuities. This resulted in a small percentage drop in standard annuity rates for men and an equivalent rise in those for women, but the changes have had less impact on the market than expected.
The importance of shopping around for the best annuity rate is, as ever, paramount. You have the right to buy your annuity from a different provider to the one with whom you saved your pension fund. This is called the open market option. It is vital you make the right choice because once you buy an annuity, you cannot change it.
The difference between the worst and the best standard annuity rates on the open market is typically 15% to 20%. But there is an increasing trend away from one-size-fits-all standard rates and towards underwriting annuities to reflect individual health and lifestyle factors.
Where insurance companies identify factors associated with a reduction in your life expectancy such as smoking, an illness or even where you live, they will offer you a higher pension income.
People with certain medical conditions can get significantly higher incomes than healthy individuals by taking out an “enhanced” annuity. That’s because their life expectancy is shorter, so the annuity provider is likely to have to pay out for a shorter time.
“If an individual with a Prudential personal pension retired today, they would be offered an income from the Prudential of £4,531 on standard rates, but if that person smokes and they shop around, they can get an income of £5,937. This amounts to over £28,000 during a 20-year-retirement,” says Williams.
McPhail, who says he has come across cases where people can be up to 60% better off by buying an enhanced annuity, points out that it is not often worth people with pension pots of under £10,000 shopping around, because few insurers will quote annuity rates on that amount. But anyone with more than £10,000 should actively shop around for the right type of annuity and the best rate.
If you do use a broker’s comparison service, either online or by phone, to arrange an annuity, a percentage of your pension pot – typically between 1% and 3% of the purchase price – will be taken as commission. Only if you take financial advice from an intermediary will they be required to charge you a fee.