Annuity rates: will recent rises continue?

Posted on January 17th, 2011 | Categories - Retirement

Over the past couple of months many Annuity providers have raised their Annuity rates. We thought we would take a look at the reasons why this has happened, whether it will continue or not, and how the recent rises could change your plans.

Why have rates risen?

There are a number of contributing factors to the recent Annuity rate rise:

1. Competition. Whenever we see a rise in Annuity rates we speak with the provider to ask the reasons behind the rise.

The answer we often get back is “competitive position”. The provider in question wants to appear at the top of the all important Annuity calculators and has therefore tweaked their rates upwards.

Indeed at least one provider guarantees, under certain circumstances, to “price match” against their competitors.

2. Inflation and Interest Rates. Inflation remains stubbornly above the Bank of England’s target level of 2% and shows no sign of falling. Indeed, most experts agree that with the recent VAT increase and petrol prices at historically high levels, inflation will continue to rise during 2011. The same experts are divided on when inflation will then start to fall.

Above target inflation increases the likelihood of the Bank of England raising interest rates. With any rise in interest rates making fixed interest assets, in particular gilts, less attractive, reducing their price which in turn increases their yield.

Yields on fixed interest assets, particularly government gilts, are possibly the single most important factor when determining Annuity rates.

Although interest rates have not yet risen, the calls for the Bank of England to make a change are becoming louder and the feedback we have had from Annuity providers is that they are already pricing in an interest rate rise to their current Annuity rates.

3. QE2 now less likely. Quantitative Easing (QE) has only been used once in our economic history, it has the effect of increasing demand and reducing supply, this pushes up prices and reduces yields.

During the Autumn of 2010 it was thought another round of QE was possible which could have increased fixed asset prices and further reduced yields.

However better than expected economic data reduced the likelihood of additional QE measures and in recent months the Bank of England have voted unanimously against further QE.

Will rate rises continue?

The message we are hearing from Annuity providers at the moment is that recent rate rises have mostly been down to a desire for increased competitiveness. Slight rises in the yields of fixed interest assets have also helped to push rates up.

However, increasing rates by decreasing margins, which is effectively what the providers have been doing if yields have not risen significantly, can only continue for so long.

The answer to whether Annuity rates will continue to rise therefore lies in the question: Are yields on fixed interest assets likely to rise?

If we knew the answer to that we would all be very rich!

If you believe interest rates will rise it is possible to make a case for Annuity rates also to rise on the back on increasing yields. This case is strengthened when you factor in the selloff of bonds that the government will have to undertake in the future.

However, how likely are interest rates to rise? Despite the popular press finally jumping on the inflation / interest rate bandwagon, there currently appears to be only one voice on the Monetary Policy Committee, Andrew Sentance, currently committed to voting for an interest rate rise.

At present an interest rate rise in the short term would seem unlikely, although for every month inflation remains above the 2% target, the chance of an increase rises.

Should I delay buying an Annuity?

This really is the $64,000 dollar question, and unfortunately not one easily answered, especially if you need income now and cannot delay.

If you feel that the recent rise in Annuity rates is attributable to providers jostling for position rather than long term economic factors, and is therefore simply a short term blip, then you may decide to take advantage of the increases and commit now to the purchase of a Lifetime Annuity.

This option has the benefit of certainty and simplicity.

However, you could take the view that we are in unprecedented times. QE has never been tried in the UK before, its effects are still being felt, and interest rates are at historically low levels with gilt yields not far behind.

Therefore why lock into a Lifetime Annuity in these uncertain times?

If you subscribe to this view but still require an income, you may benefit from looking at alternatives, which will meet your income needs now but not tie you in to a Lifetime Annuity leaving you stranded should rates rise.

Such alternatives include a Fixed Term Annuity or Income Drawdown, both come with advantages and disadvantages, which are well covered in other areas of this site.

Essentially these options put you in a “holding position” until more economic clarity emerges; of course clarity does not necessarily mean higher Annuity rates.

One thing is for certain, picking the time when you buy an Annuity has never been simple; today’s economic climate does nothing to help make the decision easier. Your choices are stark:

  1. Buy an Annuity now and live with the consequences if rates rise
  2. Do nothing, and continue to work if you do not have alternatives sources of income
  3. Look at alternative products which will allow you to take an income, as well as your tax free lump sum, whilst not tying you into current Annuity rates

Whatever you choose our team is here to help guide you through all the options and help you arrive at a solution which meets your needs both now and in the future, call one of them today on 0845 074 7778 or 0115 933 8433.

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