The same surge in borrowing costs that is piling pressure on the Government is creating an unexpected windfall for people approaching retirement.
UK gilt yields, the return someone gets from lending money to the government, have climbed to their highest levels in years.
And while this is bad news for the economy – as it means the Treasury has to spend more money servicing debt – for some retirees, the picture is very different.
This is because higher long-term bond yields can translate into higher rates on annuities – a fixed income for life that people can buy with their retirement saving pots.
Why are gilt yields rising?
The renewed conflict involving Iran and the US is part of the reason gilt yields are going up, as it has had an impact on oil prices, which is expected to mean a big rise in inflation.
Put simply, investors want a bigger return for lending when inflation, government borrowing and the economic outlook all look uncertain.
“Rising energy prices and the building risk that inflation will go higher than previously expected from food and energy is causing the market to price in more rate hikes from the Bank of England over the next couple of years. The market curve for Bank rate has gone from 3.75 per cent to 4.5 per cent. That is pushing up gilt yields at the short end,” explains Thomas Pugh, an economist at RSM UK.
Pugh also says that uncertainty around “excessive government borrowing” is also driving up longer-term gilts.
What does that have to do with your pension?
With annuities, you use a pot of money saved for your retirement, and buy an annual income with it. To provide that, insurers invest the money you give them, including in long-term assets such as government bonds.
When those bonds offer higher yields, insurers can potentially generate more from the money they receive from customers. That can allow them to offer higher annuity incomes.
15-year gilt yields are particularly relevant to annuity pricing and have reached about 5.62 per cent, their highest level in 28 years.
Data from financial services provider Legal & General shows that in 2021, a healthy 65-year-old using £100,000 of pension savings could have bought a single-life annuity paying around £4,860 per year.
Today, Legal & General says that same £100,000 could secure approximately £7,700 per year – an increase of almost 60 per cent, or roughly £2,840 more annual income.
Mike Batty, Legal & General’s director of retail retirement and product strategy, said: “Annuity rates today remain significantly higher than they were five years ago, reflecting the increase in long-term gilt yields over that period.”
Exactly what you’ll receive from your pension savings depends on multiple factors.
Andrew King, pension technical specialist at Evelyn Partners, said: “Annuity rates can, however, vary dramatically with the individual’s age, health and address, as well as the type of product chosen – with options for inflation protection, periods of guaranteed pay-outs, and joint-life death benefits.”
Batty says more people are opting from annuities than five years ago, and this partly down to rates, but also down to certainty.
He said: “Increasingly, we’re seeing people value the certainty that an annuity can provide. A guaranteed income for life can offer reassurance for those approaching retirement, or deciding to stop work entirely, particularly during periods of economic volatility.”
Legal & General research found that people are almost three times more likely to consider buying an annuity because it provides a stable income that makes it easier to plan their finances (29 per cent) than because of annuity rates alone (10 per cent).
Choosing a monthly payment from an annuity can also help people budget if they’ve been used to a monthly income and outgoings during their working life.
What are the alternatives to an annuity?
The alternative to an annuity is using drawdown, where you keep you pension pot invested and pull money from it ad-hoc.
This doesn’t give you the certainty of an annuity, but in some cases it may be more lucrative, particularly if your investments perform well.
The longer you live, the better value an annuity will prove as well.
If you use a £100,000 pension used to buy an annuity paying £8,000 per year, your money would theoretically be repaid after 12.5 years, but at the same time, the purchasing power of that £8,000 could have fallen significantly by then.
The alternative is buying an annuity with inflation protection, though this may well be smaller than you’d receive without that protection.
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