Sluggish European economy puts the squeeze on UK annuity rates

Beginning with the credit crunch in 2007, annuity rates in the UK have been steadily declining over the last five years, leaving people with the prospect of reduced incomes in retirement. Several compounding factors are cited as the cause of this by experts.

The eurozone crisis and poor UK gilt returns, as well as increasing life expectancies are working synergistically to suppress rates of income on both fixed and investment-linked annuities,says James Daly, annuities editor at the Banking Times. There is no one factor to blame but the questions surrounding the European economy are without question one of the biggest influences on the poor annuities market.

The turbulence in stock markets, largely caused by questions over the solvency and state of the Eurozone economies, is causing increased demand for UK government gilts which are seen as a relative safe haven for investors. High demand for gilts results in their prices being pushed up and causes a decrease in their relative interest payouts thus affecting the returns offered for annuity purchases.

Interest rates and quantitative easing hurt annuity returns

Faced with a tight credit market and sluggish growth in the UK economy, the Bank of England has

When credit is tight, and recession sets in, governments generally try to give the economy a kick start and the decision by the Bank of England to achieve this through quantitative easing has hit pension funds hard.

Quantitative easing fundamentally means that the Bank of England (BOE) introduces more cash into the economy c75 billion at the last round, which results in insurance companies slashing their annuity interest rates. The ongoing 0.5% interest rate has not helped pensions either. But why is this?

Well, when the Bank of England creates money in quantitative easing, it uses this to buy government gilts. This pushes the gilt prices up, which has the effect of reducing their interest payout each year. So the more quantitative easing, the more gilts are sold to the BOE and the lower their interest rate so the growth of your pension pot drops!

These drops can never be recovered, so for every boost the BOE and the government give to the economy, there is an irreversible reduction in your ultimate pension payout. The credit crunch tends to increase prices and so the effect on pensioners is even greater when credit is tight.

Increasing life expectancies also pushing annuity rates downward

Whilst the economic problems in Europe are having an adverse influence on annuity prices, it is increasing life expectancies that are having the biggest effect on annuity rates (see: more). As retirees are living longer, the value of their pension pots must be spread out over a higher number of monthly payments. This naturally means the rate at which it is withdrawn must be lower.

This trend shows little sign of changing and has been the single biggest factor leading to decreasing rates on annuities in the past three decades.