Why seizing current annuity rates makes sense

With the Bank of England (BoE) having paused the rise in interest rates, what implications does this have for retirement income planning?

The volatility in investment markets has caused concerns about the outcomes of some drawdown strategies, especially for clients at the lower end of risk profiles. The fall in the capital values of fixed income and gilt holdings has been particularly felt by these clients. Conversely, as yields have risen, we’ve seen a dramatic turnaround in the popularity of annuities due to improved rates.

This naturally leads to two important questions:

  • How long will rates stay at this level?
    • Should your clients take advantage of the rates now, even if they don’t need the income?

The relationship between inflation and interest rates has occupied much financial reporting over the last year. When we look back over the last 23 years, we can see how the two relate.

CPI v interest rates (UK)

While we’re not making any predictions on interest rates, what is interesting to see is that preceding the financial crisis, with inflation at or around the Bank of England's (BoE’s) target of 2%, interest rates were typically between 4-6%, much where they are now.

However, the 15-year gilt rate, which has a closer relationship with the annuity rate, was between 5-5.5%. At present, it has yet to breach the 5% and the level has recently fallen back to 4.5% in November. Of course, during the early noughties, annuities were by far the most popular route to secure an income in retirement.

Whereas annuities are individually priced, with variables like health and postcode affecting the rate, the prevailing rates may still be around for a while.

Should your clients take advantage of rates now?

We know that rates will improve as your clients get older, but is it worth waiting?

The movement in rates has been dramatic. For example, a 65-year-old in November 2019 could have expected £4,500pa for a single life, level annuity from a £100,000 investment. That figure at present is typically going to be £6,500pa. The underlying gilt rate has markedly impacted the annuity income that can be achieved.

Is it worth buying into the prevailing rates when your clients don’t yet need the income?

If rates stay the same, then, based on £100,000 (single life, level, male):

  • A 65-year-old would receive an income of £6,560pa
      • If he waits until 70, then he’d receive a higher income of £7,430pa

However, think about the lost income.

In the five years that the purchase was delayed, the total income received would be £32,800. It would take a staggering 37.7 years to make up that income difference. In other words:

  • When starting an annuity at 70, the income received by age 85 would equal £111,450
      • By comparison, when starting an annuity at 65, the income received by age 85 would equal £130,000

The old adage that you don’t better your health as you get older may apply, and in this case, your clients may qualify for enhanced rates. But this also assumes that they’re less likely to live longer.

Buying the annuity now but not needing the income

The argument for not taking the annuity early is that the income quite often isn’t needed. Your clients would be better off leaving their pension invested.

However, and this is an important point to consider, there aren’t too many investments that offer a guaranteed return of 6.5%.

Guaranteed income

It’s here that our Retirement Account can help. Within the drawdown element of the account, you have the option to purchase a guaranteed income. The rate of this income is aligned with our annuity rates. Although you can’t have all the same options, such as GMP, the big difference is that it pays this income into the SIPP bank account under drawdown rules. This allows it to be re-invested into your clients’ drawdown funds.

As it never leaves the account, your clients haven’t paid tax or triggered the MPAA. Moreover, if your clients choose to invest the funds into the markets, they could benefit from pound cost averaging if their annuity income is being paid monthly.

Fixed term annuities

The changes in annuity rates have also benefitted fixed-term products. Fixed-term annuities can suit all types of clients seeking a regular income with certainty at the end of the term.

Some reasons why a client would consider a fixed-term income plan:

  • Security, offering an income ‘bridge’ between retirement and state pension age
  • Client is not keen on locking into a lifetime annuity at this point but wants security over income for the term of the plan and flexibility over any future decision
  • Client doesn’t qualify for enhanced lifetime annuity rates today (no health or lifestyle to declare) but thinks they may in the future
  • Note that once the plan is set up any income and/or maturity value is set for the term of the plan and cannot be changed

More details on Canada Life’s fixed-term products can be found here.

Written by Paul Speight, Head of Business Development, Canada Life.

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