It is not just equity prices which have fallen as a result of the financial fallout of the global coronavirus epidemic, annuity rates have crashed as well. As a result, annuity rates have fallen by 7% since the beginning of the year.
Annuity rates are priced with reference to the yields on long term fixed interest investments such as gilts and corporate bonds.
The benchmark gilt yield (15-year gilt as quoted in the FT) has fallen through the floor. At the beginning of 2020 the benchmark gilt yield was just over 1% but recently it fell to 0.4%, before bouncing back to 0.5%. These are the lowest level since I started recording yields 20 years ago.
Gilt yields have fallen as direct result of the flight to quality as investors sell equities and buy secure gilts. As more people buy gilts the price rises but the yield falls.
In practical terms, a £100,000 joint life annuity for a couple aged 65 and 60 paid £4,188 per annum gross in January but today the same annuity will only pay £ 3,900 per annum. This is a £ 288 per annum drop in income which is a fall of nearly 7%.
If this is not enough bad news, investors will have experienced the double whammy of falling stock markets and falling annuity rates so someone looking to convert their pension pot into a safe annuity needs to consider both the value of their pension pot and current annuity rates. Those lucky enough to be in cash and in need of a safe income should still consider purchasing an annuity but those who have seen the value of their pension pot fall need to think seriously about the timing of any action.
The last time something like this happened to annuities was after the Brexit referendum in 2016 when the benchmark annuity fell to about £ 3,800 but yields only fell to 1%.
Market conditions are much worse than in 2016 so we can expect more trouble ahead.
The outlook for annuities is not good especially after the Bank of England issued a bond in late May which effectively meant the government was borrowing at negative rates for the first time. This means that investors expect more economic stimulus from the Bank of England which will probably keep intertest rates and annuities at low rates for the foreseeable future.
I explain annuities as being like a mortgage in reverse. You transfer your money to an insurance company who then repay your original capital plus interest in monthly instalments for the rest of your life.
The problem is that with low interest rates the payments are mostly repayment of your original capital so there is very little interest.