Submitted by: Brian Flindall
Annuity rates picked up in the past few months as gilt yields rose but don t buy an annuity just yet because long term gilt yields may rise further in the coming months. For people approaching retirement and watching the relentless oneway traffic of declines in pension annuity rates, the small rise in average rates at the beginning of this year was welcome news.
No sooner had the rise been recorded than advisers were online and in print telling pensioners and those nearing retirement to take advantage of this move and lock in rates now.
But is this the right time?
After the battering that annuity rates had last year down by around 10% across the board at the end of a 15 yea
downward spiral in which rates have halved there may be a temptation to take any small crumb of comfort and
lock in now before it gets worse.
Why have annuity rates declined?
The almost uninterrupted decline in annuity rates in the past 15 years is a product of two main drivers.
First is the inexorable rise in longevity. We insist on living longer, so our pension pot has to last longer. There is not much we can do about that other than find comfort in the thought that a longer life is better than the alternative.
The second driver is less equivocal. The decline in longterm gilt yields in the UK has been such a longstanding phenomenon that it, too, can pass as a secular trend. Insurance companies will convert a pension pot into investments principally in medium and long term government bonds to produce the required income to pay for the annuity. If the income payable from gilts is lower, then annuity rates will tend to fall.
Longterm gilt yields have more than halved in the past 20 years from well above double figures to around 3.9% for 10year maturities and 4.4% for 30year bonds. The path of annuity yields has tracked the path in gilt yields closely.
So with longevity on a relentless climb and gilt yields on an unhelpful decline, the siren call of the advisers crying lock in now before you regret it is one that cannot be ignored.
Why have rates risen recently?
But hold on there. Why have annuity rates picked up in the past month? Despite the cold weather, life expectancy has not suddenly declined. And what about gilt yields? Sure enough, in December and early January there was a sharp rise in yields, with the 10year yield at the end of November at 3.5% and 30year yields at 4.10%, hence annuity rates firmed up.
Some commentators doubt that the rise in yields will continue. They argue that shortterm yields are at historic record lows at levels close to zero, making longterm government bonds very rewarding even at 4%. If you accept this view, you would buy an annuity now. However, I side with those who take the opposite view, expecting yields to go higher.
Why gilt yields may increase
I expect yields to go higher for the following reasons:
A large gap between shortterm and longterm rates is essential to restore bank profitability and repair balance sheets. This is crucial in helping to rebuild bank margins between traditional short term deposit taking and long term
ank lending. This is particularly important if the government is serious in wishing to see banks lend more rather than focus on profits from the non lending activities that are so much in the headlines today. As short rates cannot go any lower, longterm yields must stay high for this gap to be maintained. But what is the mechanism for higher longterm
The outlook for gilt supply and demand is plain ugly. At the end of last year the outstanding amount of government debt went above 50% of GDP for the first time since 1977, just around the time the UK was last in discussion with the International Monetary Fund. This financial year the budget deficit will double from last year at around 200 billion that is a seriously scary 14% of GDP. That is Greekstyle deficit. Already gilt auctions are disappointing and this can only get worse as the stock of quantitative easing (QE) reaches its limit. Last November, the market panicked at the suggestion that the QE tap had been turned off. Sovereign credit risk concerns will add further pressure fo
higher yields on UK government debt.
Risks to gilt yields
There are two risks to this view that longterm yields will rise. One is that the UK economy has begun a selfdriven
ecovery that will ease the budget deficit without causing inflation. The second risk is that the postelection
government may take a hard line on reducing the public deficit.
The first risk is highly unlikely. The jump in inflation and fall in unemployment in the latest month must not be misread. The rebuilding of household and banking sector balance sheets is far from complete and will keep the demand
and supply of credit low as the economy continues to deleverage. I expect economic activity data to disappoint for some time to come.
The postelection risk cannot be discounted but there is time to wait and see after all, this is a onceinalifetime
decision. Waiting before buying an annuity could be well rewarded for the first time in many years.
For bespoke pension and annuity advice contact Credencis.
Credencis are situated near to Derby, Leicester, and Nottingham.
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About the Author: Independent Financial Adviser