Annuity rates were hacked back to record lows in 2015

Workers retiring this year could get thousands of pounds less for their pension pots than those who stopped working in 2014, new figures reveal.

Annuity rates were slashed to record lows last year, and those suffering from ill health have seen the most dramatic cuts. 

This time last year, a 65-year-old saver would have received £2,727 a year in exchange for their £50,000 nest egg. But this month the figure has plunged to £2,573 – a drop of 5.6 per cent or £154 a year.

Meanwhile someone with a medical condition but the same-sized pension pot would have seen their annual income drop by 6.5 per cent to £3,037, the figures from comparison website Moneyfacts suggest. 

FIND FULL DETAILS OF ANNUITY RATE DECLINES BELOW 

Unpopular products: Pension freedom means people can avoid buying annuities, which are out of favour due to their poor value, and opt for income drawdown plans instead

Unpopular products: Pension freedom means people can avoid buying annuities, which are out of favour due to their poor value, and opt for income drawdown plans instead

So-called enhanced annuities typically give a higher income, but payouts have plunged by between five per cent and 13 per cent over the past year, the analysis showed. 

Income from a joint life version of the same annuity, where payments continue to a spouse after the holder’s death, plummeted 8 per cent to £2,425, according to data comparison website Moneyfacts.

Annuity rates have been hacked back across the board – hitting their worst levels ever 10 days after the April 6 pension freedom reforms, which removed the need to buy the unpopular products to provide an income for life.

The cuts are being driven by three main factors, said Moneyfacts. 

These are: 1) further falls in the yield from gilts – UK Government bonds that are used to produce annuity income 2) reduced customer demand, which makes providers charge more to compensate for the loss, and 3) new Europe-wide rules that mean annuity providers must hold more cash on their books rather than doling it out.

The average income from an typical annuity has fallen by 56 per cent since Moneyfacts began surveying the market in 1994, and annuity rates have fallen in 17 out of the past 21 years, it revealed.

Enhanced annuities have seen the biggest falls, despite becoming more sought-after since the pension freedom reforms. These have allowed over-55s to take control of their own retirement pots and spend, save or invest them as they wish – meaning they can avoid buying annuities, which are out of favour due to their poor value.

WHY ARE ANNUITIES SO UNPOPULAR? 

Buying an annuity means using your pension pot to purchase an insurance product that provides a guaranteed income until you die – there’s no chance of running out of money altogether.

Annuities used to be the main way people funded retirement, but they are now regarded as poor value and restrictive.

Returns are low after years of rock bottom interest rates and declining purchases. Meanwhile, many people don’t shop around for the best deal, or mistakenly buy unsuitable products that don’t take account of their health or provide for their spouse after death.

Sales of annuities plummeted after pension freedom was announced. Now, many more people are opting for income drawdown schemes which allow you to take sums out of your pension pot while the rest remains invested. 

Whatever you haven’t spent yet could still be growing, providing you get your investment decisions right. And if there is anything over when you die, tax changes make it easier to leave funds remaining in drawdown schemes to your children.

However, income drawdown schemes are complicated and involve investment risk.

Those with smaller retirement pots are now allowed to use to invest-and-drawdown schemes previously restricted to wealthier savers. 

But Old Mutual Wealth retirement planning expert Adrian Walker said enhanced annuities are becoming more ‘standard’ than standard level annuities nowadays as people with medical conditions still want to buy the products.

Nevertheless, he explained that despite firms seeing increased demand, and having to pay out less due to buyers’ shorter longevity, enhanced annuity rates have still fallen. 

This was down to the loss of cross-subsidies from other types of annuity and other pricing adjustments as the industry accommodates itself to changing trends since pension freedom, he said.

Walker added that enhanced annuity providers have also got better at assessing the longevity of people with different health conditions as this pool of buyers gets bigger.

Richard Eagling, head of pensions at Moneyfacts, said: ‘The fact that annuity rates have more than halved over the last two decades shows the challenge that will continue to face retirees looking for a retirement income in the year ahead.’

He said 2015 started badly due to all-time low 15-year gilt yields in January, then annuity rates hit record lows after pension freedom in April. A period of relative calm brought a recovery during the Autumn, but annuity rates ended the year as they had begun with some sharp reductions during the last quarter due to renewed falls in gilt yields.

Regarding annuity sales, he noted figures published by industry body the Association of British Insurers which showed that in the first six months of the new pension freedoms £2.17billion was invested in around 40,600 annuities compared with £2.85billion invested in 43,800 income drawdown policies.

‘The conflicting fortunes of annuities and income drawdown are even more remarkable when you consider that annuity sales totalled nearly £1.2billion a month at their peak in 2012, a period in which only £0.1billion per month was typically invested into income drawdown products,’ he said.