Does the Bank of England cutting interest rates for the first time since 2020 earlier this month signal the start of cuts to annuity rates, too?
The short answer? Yes. But the longer answer is that it depends on what happens in the bond markets.
Annuity rates began to fall after the start of the credit crunch in 2008 and the downward spiral accelerated in 2011 until the 2016 EU referendum vote when they hit their lowest levels in living memory. Rates crashed again in 2020 before starting the climb to today’s high levels.
First, it was the rise in inflation caused by Russia’s illegal invasion of Ukraine which caused annuities to rise, then the infamous Liz Truss mini-budget in September 2023 turbocharged them further.
Before 2008, the benchmark annuity (£100,000 joint life annuity, 2/3rds spouse and level payments for ages 65 and 60) paid about £6,500 per annum gross. By 2016, it had fallen to about £3,800 but, today, it is paying almost £6,400.
This represents a 40% fall followed by an increase of the same amount.
Annuity rates will probably now start to fall as interest rates do but I don’t expect them to fall quickly or by big amounts. I don’t expect them to crash in the same way they did after the credit crunch or in the period up to 2020, but rather a slow reduction over time, depending on yields.
As all good advisers know, annuity rates are priced in relation to yields on long-dated fixed interest investments, such as gilts and corporate bonds. This means the key to working out the long-term trends for annuities is to second guess the outlook for yields.
Just like equity markets, it is difficult, if not impossible, to predict the future for yields. But it does seem that, providing there are no unexpected financial or political shocks, inflation is being tamed and yields are likely to fall, so we can expect the income from annuities to fall over time too.
Although annuity rates have probably peaked, I don’t think their role in retirement planning has done the same. Providing rates do not crash to 2020 levels, annuity sales will hold up and perhaps increase for three and a half reasons.
First, annuities remain the only way of delivering a guaranteed income for life. The peace of mind and financial security provided must not be underestimated, especially when contrasted to the risk and uncertainty of the alternatives, such as pension drawdown.
Second, continued volatility in equity markets will make it difficult to take the same income from drawdown without taking undue risks. In many cases, annuities are hard to beat when the objective is to maximise income.
Finally, as the average age of people in drawdown increases, the case for annuitising at older ages increases. It can be argued that, in the past, the optimum age to arrange an annuity was between 60 and 65 but today’s optimum age may be between 70 and 75.
This means that, as people travel along their own personal retirement journey, the case for purchasing annuities gets stronger the older they get.
And the half reason? As advisers and their clients increase their knowledge and understanding of annuities, the more likely they are to view them as a positive force for good as part of a combination of solutions rather than just a policy for those with small pension funds or who are risk adverse.
William Burrows is founder of the Annuity Project and financial adviser with Eadon & Co
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