We often wish for a crystal ball in life. Knowing what was around the corner could make some of our big decisions easier, including our financial decisions such as when to buy an annuity. With annuity rates at a depressing low, many people are toying with buying an annuity now or putting it off for a few months until rates (hopefully) recover. But with a range of legislative, regulation and market changes on the horizon picking the right time may prove problematic.
Over the past few years annuity rates have fallen steadily, partly because of market uncertainties, quantitative easing and increasing longevity. Although there may be a few upward blips over the next year or so, it is unlikely that this downwards trend will be reversed. Certainly the continuing improvements in longevity means it is doubtful annuity rates will soar any time soon. But there are other factors at play which will also have an effect on future annuity rates.
Market factors affecting the cost of gilts continue to cause havoc. With the latest round of uncertainty in the Eurozone created by the Greek election, it’s increasingly becoming a case of asking ‘when’ Greece will leave the Euro, rather than ‘if’. The timing and manner of its departure – measured and planned or chaotic and untidy – will put pressure on UK gilt yields as investors flock to find safer alternatives, and so lowering yields.
There are also a couple of key European legislative changes which will have big repercussions for the UK annuity market. The European Court of Justice gender discrimination ruling means from December this year annuity rates have to be the same for men and women, but only if the annuity is bought from a contract-based pension, including group personal pensions. Annuities bought by occupational schemes can continue to use gender as a factor when determining rates.
Currently, women are offered lower rates than men because, on average, they live longer. It may, therefore, be advisable for men to buy their annuity now rather than later when rates may fall. And, on first glance, women may think about delaying buying their annuity until later in the year. However, as over 80% of all annuities bought are bought by men, it’s highly unlikely women will benefit from a sharp increase in annuity rates after December. And any small increase in rates could be wiped out by other movements in annuity rates caused by other market factors.
The other big piece of European legislation is Solvency II, which is due to be introduced from January 2014. Currently, its exact effect on UK pensions is unknown, as we still wait for vital detail and final rulings. At its heart is the basic principle of making sure providers hold sufficient capital. And although, the impact doesn’t look as significant as originally predicted it is still highly likely that annuity rates will noticeably fall. The only question is by how much?
With an increasingly sophisticated retirement market, there are a number of product solutions that could possibly help people hedge their bets on predicting annuity rates. Drawdown allows people to put off buying an annuity until a more suitable time, but it has also seen income constrictions caused by low gilt yields, lower GAD tables, and a reduced GAD rate of 100%. Others may want to consider investment-linked annuities, which whilst still benefiting from any upside from market growth, also allow a 120% income withdrawal.
Fixed term annuities are also being seen as an alternative to lifetime annuities. But although they may give clients who become ill wriggle room to buy an enhanced annuity later on, they may not prove that useful in avoiding low annuity rates. After all, few would predict annuity rates will be higher in five years’ time. And a guaranteed capital return, incorporating a low investment return, coupled with lower annuity rates may simply mean that the client, at best, can continue to buy the same level of income as they originally set out with, rather than seeing their income rise.
Instead of playing timing guessing games, the conclusion may simply be for clients to buy an annuity when they need the income. The focus, instead, should turn to product solutions. Increasingly more people should not be settling for a simple lifetime annuity. Instead, their medical and lifestyle factors may mean they can qualify for an enhanced annuity. In addition, a growing number of retirement products allow clients to build in much-needed flexibility to suit their changing needs and circumstances.
These days, a crystal ball may no longer be as useful. Instead, the retirement product choice is growing as important – if not more important – than the timing.
Article first appeared in Professional Adviser (May 2012)
