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Alternative thinking

The summer is normally a relatively quiet time for the annuity market. This summer was no exception, with little movement in annuity rates, but this disguises the easing of annuity rates in 2009 which was a direct result of quantitative easing.

Our benchmark annuity rate (male 65 female 60, joint £100,000 level) was at £6,747 in December 2008 and fell as low as £6,088 in May 2009 before rising to £6,177 in July. This simply reflects the movements in fixed interest yields. Our benchmark gilt was as high as 4.8 per cent towards the end of 2008 but it fell as low as 3.5 per cent in March 2009 and at the beginning of August it was just below this year’s high of 4.5 per cent.

Those with a keen eye for figures may ask why annuity rates are some 8 per cent lower compared with eight months ago while gilt yields are only down by three basis points? The answer may be that insurance firms are quick to cut rates when yields are falling but slow to increase them when yields are rising.

The future for annuities is hard to predict and the effects of easing on future pricing is uncertain. On the one hand, some argue that by printing money, the Government is creating a future inflation time bomb and yields will have to rise. On the other hand, other commentators argue that deflation is the worry and yields will remain low.

Herein is the biggest issue for pensioners. Do they buy a level annuity now and maximise their starting income, do they invest in an inflation-linked annuity or defer their annuity purchase in the expectation that rates will rise?

Many people are understandably tempted towards the highest starting income but investors should be concerned about the reduction of their spending power if inflation returns with a vengeance.

One of the problems is that the returns from inflation- linked annuities look so unattractive. For example, the starting income from an inflation-linked annuity is about 30 per cent less than a level annuity. The option to defer an annuity is only for those able to accept the risk that they might in fact get less income in the future, not more.

Investors do not know how long they will live, if equity prices will rise or fall or what the future level of inflation will be, so it might make more sense to consider a combination of annuity and or drawdown products, perhaps part- level annuity part-with-profits or fixed term. The annuity alternatives provide investors with the potential for income growth and/or some flexibility if changes are needed. Annuity rates may be easing but most people’s expenditure is heading in the other direction so careful planning is needed.

Annuity alternatives provide the potential for income growth and/or some flexibility if changes are needed

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