Retirement: When should you buy your Annuity? Now or wait?

With volatile stock markets and falling Annuity rates the timing of an Annuity purchase can be tricky.

We thought we would take a look at the advantages and disadvantages of buying your Annuity now.

Buying your Annuity now – Advantages

Income now. This might sound pretty obvious but the main advantage of buying an Annuity now is that your income will start immediately. This is clearly important if you are finishing work and need to replace the income you will lose, it also helps to reduce the cost of delay, more of which later.

Today’s Annuity rates. Any pension calculator will show how far Annuity rates have fallen over recent months.

Our own figures show that a male aged 65, with a £100,000 fund, would get £823 less per year buying an Annuity now compared to June last year. That is a massive difference and is largely due to falling gilt yields, which are lower because of the crisis in the Eurozone and the Bank of England’s policy of Quantitative Easing (QE).

Will Annuity rates continue to fall? Our view is ‘Yes’. Why?

Well, firstly no one knows when the Eurozone crisis will come to an end, which means investors will continue to look for a secure home for their capital. UK gilts are a popular choice, with at least one ratings agency, Standard & Poor’s saying the UK will keep its valued ‘AAA’ credit rating, at least for the time being.

Secondly, despite last week’s announcement that the UK remains in recession, gilt yields actually continued to fall.

Finally, with inflation falling back closer to target levels and the UK economy still struggling to come out of recession, the Bank of England are likely to feel more relaxed about expanding the existing Quantitative Easing (QE) program, which will help to further depress gilt yields.

EU Gender Directive. For men considering buying an Annuity before the end of the year, there is the EU gender directive with which to contend.

Put simply this piece of EU legislation will mean insurers will not be able to discriminate between men and women. At the moment men get better Annuity rates than women as they have shorter life expectancies. From 21st December 2012 Annuity providers will have to give men and women the same Annuity rates.

The Treasury believe that the EU Gender Directive could mean Annuity rates fall by up to 13% for men; on top of the falls linked to lower gilt yields, this could have a huge impact on male Annuity rates.

If you are male, and considering an Annuity over the next couple of years, you need to consider the implications of the Gender Directive. To help we have produced a table which shows when insurers plan to start ‘pricing in’ the Gender Directive, click here to see the table.

Solvency II. Another piece of EU legislation that could reduce Annuity rates.

In the wake of the financial crisis the EU decided that institutions should hold more capital in reserve and came up with Solvency II.

Solvency II is more complex than the Gender Directive and the exact terms are still being argued over, meaning that it is harder to predict the impact on Annuity rates. Although it seems pretty certain it will do nothing to improve them, after all, if insurers need to increase their capital reserves there will be less to pay out to people buying their Annuities.

Cost of delay. If you are thinking of delaying your Annuity purchase then you should consider the cost of delay.

A male aged 65 now, with a wife three years younger and a pension fund of £100,000, would get an income of £5,389, before tax, assuming a level Annuity, with a 50% spouse’s pension and no guarantee.

Now compare that with delaying for a year.

During the year’s delay the pension fund may fall back in value, stay broadly the same or indeed rise. For the purposes of this example let’s say the pension fund stays the same, because the investor has moved to a Cash fund (see below) and Annuity rates don’t drop, despite our predictions of further falls.

The income payable in a year’s time would therefore be £5,505 per annum.

By waiting a year an extra £116 per year would be payable, but the delay has caused the Annuitant to miss out on a whole year’s income meaning that he would have  to live an extra 38 years, to recoup the additional year’s income assuming a tax rate of 20%.

Stock market volatility. When they come to us for Annuity advice most people are still invested in the stock market. This can be dangerous with sharp falls an increasingly regular occurrence over the past few years.

The alternative is to move to a Cash or Deposit based fund at some point in the year or so before retirement. The problem with this is that the returns are low, often near zero, being wiped out by the Annual Management Charge.  generally well below the Annuity rate, making the case for bringing forward the purchase of an Annuity even stronger.

Buying your Annuity now – Disadvantages

Annuity rates may rise. Our view is that Annuity rates will not rise over the foreseeable future; of course we could be wrong.

So despite our view what could cause Annuity rates to rise?

The big thing that would need to change is for gilt yields to start to rise. For this to happen some pretty fundamental changes need to occur. Firstly a downgrade in the UK’s credit rating could make gilts become less attractive, although this was not the case across the Atlantic when the US government were downgraded.

Secondly at some point the Bank of England will have to call a halt to their Quantitative Easing program and start selling the gilts it has been stockpiling, which in turn will push down prices and push up yields, this will undoubtedly happen at some point but that is likely to be measured in years rather than months.

We believe that these things are unlikely to happen, that Annuity rates will continue to fall for some time to come, and there is no upward pressure on the horizon although for the sake of all would-be retirees we hope we are wrong.

Additional tax. One of the reasons often given for delaying an Annuity purchase is that additional tax will be paid on the income received.

This is clearly a disadvantage, but has to be weighed up against the other benefits and factored into any cost of delay calculation.

Future enhancements. It is becoming common knowledge that an Enhanced Annuity, which takes into account any health or lifestyle issues, can provide a higher income in retirement. It is also fair say that as we become older we become generally more unhealthy and should therefore more likely qualify for an Enhanced Annuity.

By delaying your purchase of an Annuity you may well qualify for an Enhanced Annuity if your health worsens in the future.

This is of course far from guaranteed; we’d hope you stay fit and healthy for the rest of your life!

Next steps

If you are planning to retire over the next couple of years and would like advice on the timing of your Annuity purchase, or indeed to discuss the options you have, then do not hesitate to contact one of our team of Independent Financial Advisers.

Our team of Independent Financial Advisers are experienced in developing retirement income strategies for clients the length and breadth of the UK. If you are approaching retirement and would like advice on your options call one of our IFAs today on 0115 933 8433, alternatively enquire online or email info@investmentsense.co.uk