Buying an annuity with your pension fund used to be the only way for most people to finance retirement. The bad news today is that annuity rates have been hammered by the stock market , and this combined with a gradual decline of rates, first seen back in the 1990s, is making an annuity pension look like an increasingly bad deal for the consumer.
An annuity is a monthly income for life and up to recently it was a legal requirement that all pension funds had to be converted to an annuity at the age of 75. This law bought in by government legislation, was to make sure that people had the adequate means to pay for their care in later life. However, it did not take into account the wishes of the consumers or the performance of the annuity providers and the interest rates.
Even if you have built up a large pension pot, an annuity pension can work out at a very low income. For example, a man of 65 could swap a £100.000 pension fund for a yearly income of just £4,749 (with annual retail price increases included) or approximately £7,800 per year without RPI increases. Not a good return on such a big investment and by no means the lowest rate offered . In addition, if he should die the day after he opened the annuity, the annuity provider would keep the rest of the fund.
Annuity rates started sliding back in the early 1990s and have halved since then. One reason for this is that people are living much longer today than in previous generations, so the annuity provider will have to fund the lifetime payment for a much longer period. Investing in annuities has become riskier for the provider and this has caused the rate to fall dramatically.
The recent economic crisis has also had a big affect on annuity rates and 2009 saw rates fell to an all time low. The general uncertainty and lack of confidence in gilts (government bonds) and corporate bonds which the annuity companies invest in, have led to low annuity rates as the companies pass on the cost of the risk to the customer. In this economic climate the annuity rate is not predicted to rise in the near future.
So where does all this leave the customer? Annuities offer poor value at the moment and other methods of financing your retirement that do not lock you in to a long-term contract at a low rate would be a safer option. And after all, if the annuity rate rises you can always buy later when the market is more favourable.