Level or RPI Annuities as Rates Higher in 2023?
Published / Last Updated on 14/07/2023
Interest Rates Are Higher - Impact
Interest rates are forecast to hit a 25-year high over the next few months and if they hit 7%, it is not only homeowners and those with debt that will struggle, it is also the Government and it’s borrowing costs. UK Government borrowing costs are indirectly linked to Bank of England base rates. If you can lend your money to a high street bank and get 4.5% on deposit, why would you ‘lend’ your money to the government in the form of Gilts unless they are paying higher rates. The gilt yield is the interest rate that the government pays on its borrowing, and it is now higher.
Gilt Yields and Annuity Rates
Governments borrow money from finance institutions such as pension funds. Your pension fund may offer fixed interest and index linked bond funds; this is where investors money in those funds are loaned to the government for a % return (gilt yield). Equally, annuity providers lend your pension money to the government.
- You give your pension fund to an annuity provider.
- Annuity provider lends money to the government for a fixed or index linked (inflation linked) gilt yield return. This is guaranteed by the British Government and then at the end of the term the government repays its loan to the annuity provider (just like an interest only mortgage).
- By receiving a guaranteed income (gilt yield), your annuity provider is able to offer you a fixed (level), % increasing or RPI increasing annuity income.
Interest Rates High – Annuity Rates High
Given high interest rates, gilts yields are higher and therefore annuity rates are higher, in some cases the highest they have been for 25 years. Annuities are now back in vogue as an attractive, low risk return for your pension fund.
Level Annuity v Inflation (RPI) Linked Annuity.
We looked and compared sample annuity rates for a person aged 60 and 65 on both a level annuity and RPI linked annuity to establish which offers better value?
Currently, fixed for life annuity rates at 6.69% for a 60 year old and 7.436% for a 65 year old, appear to outperform the average RPI linked annuity for the same people. Both inflation and life expectancy are unknown but we have assumed inflation at 2.5% pa as this is the average RPI measure over the last 70 years as well as considering higher than average inflation increases at 3.5% pa.
It is worth completing the same exercise if you are looking to buy an annuity. Do not just go for the level annuity or index linked annuity, calaculate the average over 25 or 30 years. Level annuities currently offer more upfront but your gradually become poorer as prices increase over the coming years.
