Annuity Update Dec 2019
Will annuity rates go up or down next year?
The outlook for annuities is inextricably linked with the future trends in long-term yields. So, the question is will yields increase next year? If so by how much and how will this affect annuities?
Just over 12 month ago, on the 1st December 2018 our benchmark annuity rate (£100,000 joint life annuity with 2/3rds partner’s pension for a couple aged 65 and 60 with level payments) was £ 4,680 per annum before tax but on the 1st December 2019 this has fallen to £ 4,100. This is a drop of 12% or £ 578 per annum.
£ 578 may not seem like a lot of money but multiplied by the number of years the annuity may be in payment this could equally add up to over £10,000 over the course of someone’s lifetime.
The reason why annuity rates have fallen is simple; the interest rates on which annuities are priced have fallen. A year ago, the yield on the benchmark gilt was 1.8% but now (14 December 2019) it is 1.13%.
The chart below shows the changes to the benchmark annuity and gilt yields.
Strictly speaking, annuities are priced in relation to yields on fixed interest investments including corporate bonds and commercial property yields but gilt yields are a useful barometer for annuities.
Rule of thumb
How can such a relatively small drop in yields result in such a big fall in annuity income? The answer is that for every 100 basis points fall in yields (e.g. from 2% to 1%) annuity rates will probably fall by 10%. This year, 67 basis points has resulted in a 12% fall so it seems annuity rates have fallen more than they should have.
My rule of thumb is approximate and should be taken with a pinch of salt but it does show how depressed annuity rates are and may give an indication of how annuity rates may improve in 2020 if yields bounce back to last year’s level.
What will cause annuity rates and yields to rise? The answer may be Brexit.
On the one hand, the new Government’s large majority may give a boost to the UK economy and put to rest the need to cut interest rates and could lead to an increase in bond yields. But on the other hand, the effects of Brexit could result in lower economic growth and the need to cut interest rates to stimulate growth resulting in even lower yields.
If we look back to the 2016 EU referendum we see the beginning of a sharp fall in yields and annuities and by Christmas 2016 both were at an all time low. It was not until Christmas 2017 that annuity rates returned to pre 2016 levels. This Christmas annuity rates are higher than before the UK voted to leave the EU.
Will 2020 be the year of the annuity?
It is difficult to predict the direction of travel for annuities but with the fear of economic turmoil resulting from a no-deal Brexit receding for the time being, significant falls in annuity rates should be avoided.
I am hesitant to predict the 2020 trend for annuities as I have got it wrong in the past. I did predict 2017 would be the year of the annuity (https://www.retirement-planner.co.uk/232480/william-burrows-2017-wasnt-year-annuity) but I was clearly wrong about that.
However, there are good reasons to think that 2020 will be a better year of annuities as the Brexit uncertainty fades away. On balance, providing the UK’s finances don’t end up in a mess I predict a slow increase in annuity rates and more retired investors converting their pension pots into income by purchasing annuities.