Does the interest rate on annuities add up for those taking out a pension?
The low interest rate environment is complicating calculations for those about to go on pension
Earlier this year, the Daily Telegraph asked its readers to “spare a thought for Irish pensioners”. Why? Because Irish annuity rates are typically of the order of less than 5 per cent, while British pensioners are enjoying a more bountiful retirement with rates closer to 6 per cent. But why the differential? Could there be another solution to annuities and what impact has the recently introduced Gender Directive had on pricing?
Annuities are typically purchased by pensioners from life companies with the proceeds of their pension policy, in return for a fixed rate of income until they die. For many pensioners they are attractive because they take the investment risk out of your pension. But how much a person gets typically depends on interest rates. Back in the 1980s, for example, you might have reasonably expected to get an annuity rate of about 10 per cent, which would have given an income of about €10,000 a year on a €100,000 capital sum. These days, however, a 65-year-old buying a joint-life policy with a similar sum will probably only get €4,500 a year.
The problem for Irish pensioners is that Irish-based insurance companies invest mainly in European government bonds – and the yields on these bonds are at historic lows.
“At the moment, yields are quite low relative to historic norms although they have picked up slightly,” notes John Geraghty, chief executive of LA Brokers.
For Owen Morton, chairman at Moneywise Financial Planning, annuities represent “notoriously bad value” today. He notes that they now stand at less than half of where they were 20 years ago.
“No-one having a choice in the matter should buy an annuity today,” he advises.
Spouses not protected
One outcome of the current low rates on offer is that, in the search for a greater income, those opting for an annuity are failing to get cover for their spouses.
Morton points to a survey conducted by his firm which showed that some 70 per cent of those who had purchased annuities opted for a single life. “They were under pressure to get as much income as they could,” he says. You could expect your income to drop by about €400 a year on a €100,000 capital sum to get a joint-life annuity.
But if you should die with a standard, single-life annuity, the husband or wife you leave behind won’t get anything. It will go straight back to the insurance company you bought it from.
Another issue is that people are failing to get their income protected against inflation, probably because index-linking your annuity comes at a considerable cost (see table below right).
But despite the risks, 90 per cent of people opt for a flat rate option, Morton says. In an era of low inflation, this can make sense, but should things change, people might struggle to survive on their incomes.
With rates on offer so poor, it makes sense to shop around. One of the easiest ways of losing income in retirement is by being a “captive” customer and sticking with the life company that sold you your pension in the first place.
As the table shows, there are about six main providers in the marketplace, so do your research first and make sure you get quotes from all the providers. And remember, ask about how commissions and charges are affecting your income.