Why The Credit Crunch Is Good For Your Pension
The credit crunch has been bad news for many of us, but it's a different story if you want to take an income from your pension.
Great news if you're thinking of taking benefits from your pension. Annuities -- which convert your pension fund into an income -- are enjoying higher rates now than they have done for the last five years. And it's all thanks to the credit crunch which has given the humble annuity a welcome boost.
Why are annuity rates rising?
Annuities have long been criticised for providing poor value for money, but the tide appears to be turning at long last. They seem to be one of the very few winners out of the credit crunch.
In a nutshell here's why annuity rates are on the up: The credit crunch has forced the value of corporate bonds (or company debt) to fall while conversely, bond yields have risen sharply. Given that annuity companies invest heavily in corporate bonds, this in turn has allowed annuity rates to surge.
Take a look at annuity rate trends over the last ten years:
Annuity Rates: 1997 - 2007
Average Male Rate (annual income) | Year On Year % Change | Average Female Rate (annual income) | Year On Year % Change | |
|---|---|---|---|---|
December 1997 | £883 | - | £801 | - |
December 1998 | £758 | -14.16% | £681 | -14.98% |
December 1999 | £747 | -1.45% | £674 | -1.02% |
December 2000 | £755 | 1.07% | £695 | 3.11% |
December 2001 | £702 | -7.02% | £645 | -7.19% |
December 2002 | £621 | -11.54% | £578 | -10.39% |
December 2003 | £611 | -1.61% | £574 | -0.69% |
December 2004 | £602 | -1.47% | £567 | -1.22% |
December 2005 | £586 | -2.65% | £543 | -4.23% |
December 2006 | £585 | -0.17% | £547 | 0.74% |
December 2007 | £622 | 6.32% | £582 | 6.40% |
Change over 10 years | - | -29.56% | - | -27.34% |
Source: Moneyfacts. Based on a person aged 60 buying a standard `level without guarantee' annuity for a purchase price of £10,000
As you can see, annuity rates have dropped almost 30% for men and 27% for women over the last decade. This has been brought on by a combination of increased life expectancy and falling interest rates.
But a long-awaited upturn took place in 2007, with rates increasing by more than 6% for everyone. And that trend should have continued so far this year. Better still, rates are higher now than they were back in 2002.
Why you should think about taking your annuity now
Choosing the right time to buy your annuity is far from easy. It's very tricky to second guess what's going to happen with annuity rates in the future. The right time largely depends on your own individual circumstances. But here are some other points to consider before you make your decision:
Firstly, further reductions in interest rates could drag annuity rates down again.
Secondly, figures from financial research company, Defaqto, demonstrate how you could get more out of your pension fund by taking your annuity sooner rather than later.
Defaqto say a typical level annuity* -- bought by a 65-year old male with a pension pot of £100,000 -- would provide an annual income of £7,410. But the same annuity taken at age 64 would provide a lower income of £7,234.
Remember, the earlier you take your annuity the lower the rate you'll receive, because it may have to pay out for a longer period based on average life expectancy.
So, deferring your annuity until 65 appears to offer better value for your pension money. But it's easy to overlook that you will have forfeited a whole year's income (i.e. £7,234) in the meantime. Even though you'll receive a higher level of income by waiting for one year (providing an extra £176 each year in this example), it would actually take a whopping 41 years to make up the difference (all things being equal).
Even if your pension fund grew by say, 6% between the ages of 64 and 65, it would still take 12.2 years to break even.
Open Market Option
True, you can't know for certain when will be the best time to buy your annuity. But you can make the most of your pension fund by shopping around. Make sure you compare the market to find a competitive annuity before taking the plunge. This is called using the `open market option'.
Many people buy an annuity from their original pension company. But this invariably leads to a poor deal. There's a huge difference between the best and worst annuities on the market, as rates vary considerably from one company to another. So make sure you choose the annuity with the highest rate to stretch your pension fund as far as possible.
Finally, I've already seen reports that suggest we've seen the worst of the credit crunch. Who's to say how much longer annuity companies will be able to take advantage of credit conditions to push up annuity rates? It may be a sensible move to get in while the going is good.
*A level annuity provides the same amount of income every year, i.e. it is not inflation-proofed.
More: How To Buy The Right Annuity | Enhance Your Pension Income by 25%
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