Interest Rate Rise May Push Annuity Rates Up
Published / Last Updated on 08/02/2022
Following discussions with a client last week about annuity rates, we decided to highlight our thoughts for you.
How Are Annuity Rates Set?
The government needs to borrow money everyday as we have all seen when borrowing to pay for covid-19.
Age, health, smoker status and income options such as whether you want a spouses pension on death or note clearly affect your annuity rate. In addition, you should note that when you give your pension fund to a pension company to buy an annuity income, they immediately lend that money to the British Government and buy government bonds called Gilts. These can be fixed rate gilts or inflation linked gilts. For fixed rate gilts, the government pays a fixed income to the pension company and for index linked gilts, they pay an RPI linked income. By having this guaranteed income from the government, the pension annuity company can then be secure in offering you a guaranteed income for life. This is how an annuity is funded.
If Bank of England interest rates rise, the government will have to pay higher yields on their gilts. In short, the pension annuity company can secure a higher income meaning they can offer you a higher annuity rate.
Interest Rates Rising
Given Bank of England interest rates have been increased for two months in succession now, this may mean that the Government will have to increase gilt yields on any more money it wishes to borrow via gilts. This may mean that annuity rates are set to rise.
Annuity Rates
With recent interest rate rises, annuities rates have already increased by 4-5%pa. It has been estimated by Canada Life that an increase in interest rates of 1.5% could push annuity rates up by 14%pa. We have already seen interest rates increase by 0.4%pa in the last two months, so we are only another 1%pa increase away to get to this level.
Comment
If interest rates get anywhere near where they were in the eighties, nineties and early noughties then it is not difficult to see that annuities would be back as a number one choice for retirement rather than playing second fiddle to flexible drawdown as they are at present.