Was 2017 the year of the annuity?
Was 2017 the year of the annuity? – no it wasn’t
When I wrote an annuity update for Professional Adviser in January 2017 I posed the question “Will 2017 be the ‘Year of the Annuity’?” [https://www.retirement-planner.co.uk/228904/228904] This was because it seemed that annuities might improve and there would be renewed interest in annuities.
Now, nearly one year later I can look back and say I was wrong: annuity rates remain in the doldrums, sales of annuities have not increased significantly and advisers and their clients haven’t fallen in love with annuities again.
In my defence, I did say several things needed to happen before annuities came back into fashion. For instance, bond yields would have needed to have risen significantly and advisers and their clients would have need to be convinced there is a role for annuities after pension freedoms. Neither of these things happened in 2017 but that doesn’t mean that they won’t happen in 2018.
Bond yields and annuity rates in 2017
The chart below shows how my benchmark annuity rate has changed month by month over the last year and shows there has been little significant change over the last 12 months.
In January 2017, the yield on 15-year gilts was 1.81%. It went up to 1.9% in February, fell to a low of about 1.5% in June and end up at 1.86% at the beginning of December. Not even an increase in the bank rate in November was enough to significantly change gilt yields.
With so little change in yields, it is not surprising that annuity rates have remained flat during the year. My benchmark annuity - £ 100,000 joint life 2/3rds level annuity for ages 65 and 60, started the year at £ 4,354 and on 1st December 2017 had nudged up to £ 4.585. An increase of £ 231 per annum an increase of 5%.
Most advisers will know that annuities are priced with reference to the yields on long dated bonds and the benchmark I use for analysing annuity trends is the 15 year gilt yield which is published everyday in the FT. Very simplistically, if yields increase, the income from annuities will rise and vice versa.
For the more technically minded, there is a useful rule of thumb; “for every 100 basis points change in yields, (e.g. 2% to 3%) annuity income increase by between 8 and 10%”.
Eagle eyed observers may want to ask how come annuities have increased while yields have remained flat? The answer is annuity pricing is complex and there are many other factors to take into consideration, not least that annuity providers invest mostly in corporate bonds and some property where the yields are higher than gilts.
We should be thankful for small mercies, but an extra £ 230 for a £ 100,000 annuity will not even buy a case of good champagne to toast getting a better deal!
So what about 2018?
Annuities rates will only rise if bond yields rise and just like equity markets it is not possible to predict what lies ahead.
However there several factors that may act to push yields upwards for instance increased inflation and the possibility of stormy waters ahead because of Brexit and increased government borrowing.
But don’t forget; annuities do not move in a vacuum and anybody thinking about converting their pension pot into an annuity must also keep an eye on the stock market as the amount of annuity income is depends not only the actual annuity rate but the size of the pension pot.
This means that even though rates have not increased by much, many people will be able to secure a higher annuity income now compared to the beginning of the year if their pension pot has increased in value because of good equity returns.
But watch out because if equity prices were to fall, annuity rates may rise but the overall annuity income may be less if there is less money in the pension pot to buy an annuity.
This is something those in drawdown should watch out for, because if there is trouble ahead with Brexit it might make sense to partially de-risk drawdown by locking into guaranteed annuities.
My prediction for 2018
I appreciate I haven’t answered the question you probably want to ask; “how much higher will annuity rates be by the end of 2018”.
I don’t know is the short answer, but if you twisted my arm I would predict the benchmark gilt rising to about 2.5% and the benchmark annuity rising to about £ 5,000 per annum that is another £ 400 a year for a £ 100,000 annuity. Not a lot, but it all helps.
This is my personal view and you should not rely on this!
If you are interested in how annuities rise or fall from week to week do follow my charts at www.williamburrows.co.uk