Wednesday, November 24, 2010

Pension hope for babyboomer generation

The top rates on annuities – the product retirees buy to turn a pension pot into an income – held steady last month, temporarily halting their downward spiral.

It points towards potential breathing space for a generation of 'babyboomers' approaching retirement.

A raft of scare stories over the summer suggested that millions of over 50s are on a 'collision course with an impoverished retirement'. Almost eight in ten are set to receive an annual income of just £8,000, it was predicted.

And after decades of annuity rates drifting unabatedly downwards, even a £100,000 pension pot now only equates to an income of £5,630 a year for a couple.

With the help of annuities expert, Billy Burrows at Burrows & Cummins, we take a look at what's going on.

What are annuities?

Annuities are like insurance in reverse – you pay a lump sum (your pension pot) and get monthly payments in return, guaranteed for the rest of your life.

When you hand over your life savings, an insurance company invests your pot into 'safe' assets. More often than not, these will be government bonds, known as 'gilts'.

This means the rates offered to newly retiring pensioners are largely dependent on the return – or yield – gilts are providing at the time.

What is this 'hope' for rates?

Encouragingly for those preparing to buy an annuity, the gilts yields firmed this month.

This has been helped, in part, by confidence in the stock market, with the FTSE 100 rising by 100 points since late September. With markets climbing, investors have sold 'safe' gilts, and bought more volatile shares. This pushes the price of gilts down but the yield - which is like the interest rate on any other bond - up.

The news that the UK economy grew by 0.8% in the last quarter is a good example of how this works. The positive news saw investors sell gilts, spiking the yields to a new one-month high.

Billy Burrows, an annuity expert with Burrows & Cummins, says the trend has brightened the outlook for over 60s looking into annuity purchases.

He says: 'This year it seems that yields are increasing so perhaps there is a chance that rates will increase, albeit by a small margin. But I don't think it is sensible deferring an annuity purchase in hope for higher rates because any gains will be modest.'

Why are rates so low?

For nearly twenty years now, annuity rates have been in seemingly terminal decline. Back in 1991, a £100,000 pot could have secured an standard annuity income of over £15,000 a year. In June, the level fell below £6,000. Check out the graph below for a snapshot.

Billy Burrows' benchmark measure of annuity rates shows that the average has declined by significantly over the last twelve months.

Billy Burrows: Expert annuity advice

A year ago, if a man 65 with a £100,000 pension pot and purchased a joint life annuity for him and his wife, aged 60, he would receive around £6,000 per annum. Today that same annuity pays just £5,630 - a fall of 6% over the past twelve months.

That wasn't helped by sudden cuts in bond yields in August, which sent rates plummeting by about 1% on average.

Yet, according to Burrows, things have stabilised because Canada Life – one of the biggest players in the annuity market – has held its rates firm since July.

In his regular annuity rates round-up for This is Money, Burrows wrote: 'Recently, bond yields have risen and Aviva increased rates, but then (18 October) Canada Life cuts its rates. Annuities are like a see-saw - one minute up, the next minute down.

One of the factors leading to Canada's cut will have been the need to reduce the level of new sales as it was top of the best tables for September and first half of October. Burrows says a lack of competition is also a major downward force on rates.

He says: 'For standard annuities there are only three competitive companies; Aviva, Canada Life and L&G and the lack of competition removes some of the incentive to increase rates.'

What can you do?

Be aware that there are many types of annuity. Standard annuities pay a set income that doesn't change for the rest of your life; inflation-linked annuities rise with prices of goods; and investment-linked annuities that depend on stock market performance.

Also be aware that annuity providers vary greatly in the rates they offer. You have the right to shop around for the best.

Add to that, huge swathes of pensioners don't realise they could get an annuity boost if they have health problems. Even smoking or minor blood pressure troubles qualifies you for an 'enhanced annuity', with the difference between standard and enhanced rates as much as 24%, according to annuity specialists MGM Advantage.

Craig Fazzini-Jones, of MGM, says: 'The gulf between the best and worst annuity rates for conventional and enhanced products is becoming wider, and with rates in general falling it's more important than ever to consider alternative retirement income solutions that can really make the most of people's retirement savings.

Billy Burrows says significant rises in annuity rates are extremely unlikely. His tip is to look into locking part of your pension pot into an investment-linked annuity to boost returns, while leaving the majority in a safer lifetime income product.

›› More: Latest annuity rate news and predictions:

'The logic is that if an annuity is a long-term product, it should be backed by a suitable long-term investment,' he says.

'There are basically three types of investment linked annuities; MGM's Flexible Investment Linked Annuity, Prudential's income Choice and Sun Life Financial's i2live annuity. They all provide an income for life where future payments will rise or fall depending on future returns. They have a level of guaranteed income to protect investors from a stock market crash and they allow the flexibility to change the amount of income payments or buy a different type of annuity in the future.'

- Read Billy Burrows' free guide to investment-linked annuities for more information.

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