If you are a member of a defined contribution company scheme or a personal pension, when you come to retire you will exchange the pension pot you’ve built up over the years for an annuity. The amount of regular pension you get in retirement will depend upon the size of your pension pot and the annuity rate you get for your chosen annuity.
An annuity rate is the factor used to convert a pension pot into pension income. They are calculated by the insurance companies offering the annuity and are based on several factors including – life expectancy, interest rates, gender and age.
Falling annuity rates
Unfortunately, annuity rates have been on the decline for the past few decades. This is due to a combination of factors including low interest rates, poor returns on investments and greater life expectancy.
Also affecting annuity rates is the yield on gilts (also known as government bonds). The insurance companies that sell annuities buy gilts to finance the annuity and provide annual income in retirement. If the yield (annual return) on gilts falls then the insurance company must cut its annuity rate.
The Government’s recent policy of quantitative easing has forced down gilt yields in the past year. This has hit annuity rates, reducing them even further. If you throw reduced investment returns into the equation then the amount of income we can expect to get in retirement can fall substantially.
Research by one firm of financial analysts, Moneyfacts, has found that lower annuity rates and falling investment returns have reduced potential annual income in retirement by as much as 70% in the past ten years (view the full findings on Moneyfacts) This shows just what a difference falling annuity rates and investment returns can make.
Of course the passed decade has seen two market crashes (the 2008 credit crunch and the dot com crash in 2000) which helps to explain why pension funds have performed poorly during this period. But if investment returns are down, then individuals must contribute more to achieve their pension savings goal. Equally, they should monitor their pension fund’s performance, taking action if it is underperforming, and get help from an adviser if they are unsure.
Shop around for your annuity
For most of us, an annuity is the best option for achieving regular income for life in retirement. However, with annuity rates on the decline it is vitally important that you shop around for the best annuity deal for your requirements.
It is worth remembering that there can be a significant difference between the highest and lowest annuity rates on offer for a particular annuity. This can amount to thousands of Pounds over the course of the life of an average pensioner. So it is well worth shopping around and comparing annuity rates.
Remember, once you’ve bought an annuity it cannot be changed, cashed in, or transferred so it is important that you get the right one for your circumstances and needs.
Other ways to boost your annuity
Wait a few years: As well as shopping around, you could put off buying your annuity for a few years, as the shorter the life expectancy the more income you can expect in retirement. Currently, you must buy your annuity by the age of 75, but waiting until then can boost your retirement income. Remember, the full basic State Pension will be £97.65 for a single pensioner from 6th April 2010, so you will probably need other sources of income until you buy your annuity.
Continue working: If you want to, and your employer will let you, you could continue working past the usual retirement age of 65. Or, you could take up a part-time- job to supplement your income in retirement and so allow you to delay buying your annuity.
Use income drawdown: Depending on your pension scheme, you may be able to use income drawdown. This would let you keep your pension pot invested, even after you have taken retirement, and allow the pot to continue growing in the pension fund. But if the stock market falls again and annuity rates get even lower you could be worse off than if you bought your annuity on retirement.
Less income in retirement
Annuity rates have fallen over the past decade, as have the returns on investments. This means that the amount of retirement income we can expect to receive in exchange for our pension savings will be lower. There are a few things we can do, such as saving more and/or working longer. It is also important to research your options and shop around for the best annuity.