Many investors express scepticism about the value of pensions, with low annuity rates discouraging long-term savers. Providers have started to raise rates in recent months, however, highlighting that for those not retiring for many decades, they could end up with a higher income than they might think.
Stone said: "Basically, the long and the short of it is the major drivers of annuities are government gilt rates, interest rates and how long we are now living."
"With recent QE, that has depressed gilt rates; interest rates have been low for four years, and annuity rates are a lot lower, probably at the lowest level they have ever been."
"If and when gilt rates and interest rates start returning up, annuities should rise," he said.
Ten-year gilts are currently at 2.26 per cent, up 78 basis points from a year ago. As the most risk-free investment, they influence the income received from an annuity, and with the yields from these instruments having been at record lows in recent years, it is no coincidence that annuities have also been low.
While the road forward for the economy is likely to yet be rocky, the recent uptick serves as a reminder that at some point, yields are likely to rise, and annuities with them.
It is interesting to see what the current status quo is for anyone planning for retirement.
Annuities vary widely from provider to provider, and are dependent on a number of personal factors. Your marital status, health and lifestyle could all have an effect.
A single man who wishes to retire at 68, does not want to take a lump sum and does not want to leave an income to be paid to a spouse after his death, would need a pension pot of roughly £90,000 at today’s rates to get £477.31 a month, equivalent to the current state pension.
The data comes from the state’s free money advice service, from taking the best quote for a man living in central London. Living in a less advantaged area will mean you get a higher payout.
Assuming you receive the basic state pension as well, you would be looking at an income of £954.62 a month, hardly a high-rolling lifestyle.
If you manage to save £100,000, that will give you between £468.2 and £558.7 a month depending on your provider, corresponding to a total income of £945 to £1,036.
If you manage to save £250,000, you could get an annuity of between £1,150 and £1,295.57 a month, meaning your best result would be £1,772. All figures are before you pay income tax, of course.
Annuity rates per pension pot
| Pot | High | Low |
|---|---|---|
| £90,000 | £476.43 | £430.52 |
| £100,000 | £558.70 | 468.2 |
| £150,000 | £796.12 | £699.70 |
| £200,000 | £1,062.53 | £919.76 |
| £250,000 | £1,150.00 | £1,295.57 |
| £500,000 | £2,558.15 | £2,303.85 |
Source: Money Advice Service
These figures will rise along with gilt rates and interest rates, and while this is not likely to help anyone planning for retirement in the next few years, for people with a longer investment horizon, it is worth taking into account.
Taking an annuity is the best route for the risk-averse investor, according to Stone, although he notes it is not the only option.
"The rule of thumb is if you are risk-averse, you are going to need a fixed income from the plan for the rest of your life," he said.
The other main option is drawdown. Investors who go into drawdown can choose to take a certain proportion of their pot each year as income and leave the rest invested to generate further gains.
The drawback is that you cannot be sure what income you will receive each year, and that you are likely to be reducing your capital each year.
You will also have to be a highly aware and active investor, and confident in your ability to manage your own pension pot.
Stone says that there is no need to go to this extreme, however.
"There’s now a third option and that is fixed term annuity," he explained. "Rather than drawdown release, it takes the best bits of annuity and the flexibility of drawdown to allow clients to set up an income for a fixed term."
Stone explains that the minimum period you can set up an annuity for is three years, and it is best to arrange a plan in multiples of three years – three, six, nine or 12, for example.
"This is because the maximum income they can take is reviewed every three years," he said.
"Depending on what they have got, we are seeing clients looking at them if they have sufficient fund size."
"They are available with a pension pot of as little as £10,000 upwards, but every three or six or so on years, you have to renew it. But you will have a lower figure every time you renew it, because you have drawn income from it, so it needs to be a bigger pot, maybe £50k."
"I think one of the biggest problems with pensions is you are saving for potentially 40 years, so the old adage that 'the earlier you start, the better' is true, and you are going to be in retirement longer than you think."
Stone points out that making plans based on how the world is now – both in terms of annuity rates and also the regulations surrounding pensions – is dubious, given how much the world has changed only in the past 10 years.
For this reason, you should also look to supplement your pension to diversify your risk, he explains.
"Relying on the state pension isn’t going to provide you with a sufficient income. The other thing to say is that a pension shouldn’t be the only thing you have got to rely on in retirement, you want savings and other investments, too."
