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Euro crisis leaves retirees scrabbling for pension income

The crisis in Greece will have more impact on your pension than you might think. As investors flock to invest in UK debt, annuity rates will fall even further.

 
Euro crisis leaves retirees scrabbling for pension income

Those retiring this year will feel the fallout from the Greek crisis as a rush away from the euro to ‘safe haven’ Britain pushes historically low gilt yields and pension incomes even lower.

You may not think that the amount of income you receive when you retire has much to do with the demise of the Greek economy and the turmoil in the eurozone, but you’d be wrong.

The amount of yearly income you can get when you buy an annuity with your pension pot is affected by gilts as annuities are traditionally invested in them. As the gilt yield falls, so does the income.

The yield on a 10-year UK government bonds hit a historic low of 1.92% in January, which stems from the demise of the Greek economy. Investors are shunning faltering euro countries in favour of economies that are seen as being more stable, such as the UK and US.

The newfound ‘safe haven’ status Britain has acquired has depressed gilt yields further, to 1.87%, and there are fears they could go still lower.  

A rock and a hard place

Annuitants have already seen thousands wiped off their potential income over the years owing to increased longevity and low gilt yields. In 1990 a £100,000 pension pot would have bought an income of £17,000 a year, but now it buys just £6,000 – and the figure is set to drop further.

Jason Witcombe, a director of London-based independent financial advice firm Evolve Financial Planning, said those retiring this year were ‘stuck between a rock and a hard place’, but he urged them not to make a rash decision and buy an annuity.

He said a 65-year-old retiring soon should look at whether they need to cash in their pension pot for an income yet – if they can wait, then they should think about doing so, he urged.

Witcombe also suggested staggering the purchase of an annuity, purchasing a smaller annuity with part of your pot and leaving the rest invested with a view to buying another annuity later.

‘If there is scope to delay or stagger an annuity purchase, then you should think about that. [By staggering your purchase] you spread your market timing risk,’ he said.

‘There is no right or wrong, it will be risky whatever you do [as annuity rates can go up and down at any time]. It is only with hindsight that we will know.’

Witcombe also recommended looking at whether you can enhance your annuity rate through an enhanced life annuity, which pays out more income to those with pre-existing illnesses and unhealthy lifestyles.

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7 comments so far. Why not have your say?

gggggg hjhjkl;'

May 21, 2012 at 17:54

This situation must push the case for ISA investment rather than pension investment.

I pity anyone forced by circumstance to buy an annuity now.

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Rob Walker

May 21, 2012 at 19:30

One point not mentioned is that by staggering the purchase of annuities the second / third purchase will be done when the Annuitant (sounds like an insect or an alien!) is older and therefore the income will be larger for the same initial cost.

What I don't understand though is why we are not recommended to invest our SIPPs in higher-yielding bonds and high-dividend blue-chip shares? Is it because there is not much profit for Financial services companies if we take this option? If the capital sum remains more or less constant then the GAD rates will go up as we get older and we will have the option to draw more income at the next review.

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Pilgrim

May 21, 2012 at 21:44

Interesting theory from Michelle.

However, an important reason for the high price/low return on Gilts is that in QE the BoE have been purchasing huge volumes of Gilts. It has been reported that the BoE now holds approximately one third of the all gilts in issue now on its books.

As noted pension funds often need to hold gilts to match policy guarantees and to satisfy regulatory requirements. Life is very difficult for pension providers at the moment, they are being forced to pay ever higher prices for lower income streams and are forced to compete in the market with the BoE for the diminished pool of gilts.

To what extent currency migration may contribute to the difficulty is hard to judge, but the high price can be explained primarily in terms of the effects of QE without need for other reasons.

Incidentally the view has been expressed to the effect the the acquisition of Treasury debt instrumnets by the BoE is not considered by the BoE to amount to a redemption of the Gilts, and they are held in prospect of a potential return to the market. This obviously creates great dangers of instability in Gilts pricing, and one supposes not insignificant risk to the BoE itself.

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Pilgrim

May 21, 2012 at 23:39

I agree with Rob Walker. I think that the recommendations made in the article are not well reasoned.

The problem facing the pensioner is that we are in the midst of a period of great instability in financial markets. This instability affects almost every type of asset and has resulted in an unsustainably low official interest rates.

The objective of the pensioner must be to preserve as much as he can of the real value (i.e. providing for the effect of inflation) of his pension fund into the future when it will be needed. Nominal value can just about be protected by holding fixed interest gilts to redemption. But this does not protect real values, and with the return on gilts now well below the rate of inflation reliance on Gilts alone guarantees a loss in real value. Index linked gilts held to redemption are marginally more satisfactory because the risks associated with inflation are substatially addressed. However, the robust qualities of IL stock has not escaped the notice of the market, and present pricing reduces the real rate of return available substantially. Putting it simply whereas holding fixed interest gilts is like having a full bucket of water with a small hole in it, holding IL gilts is like having a water tight bucket filled three quarters full. In the long term you are better off with the watertight bucket (but you have to live long enough, compos mentis, to see the benefit).

Annuities are based primarily upon gilts. As noted the BoE has forced interest rates down to a far lower level than is compatible with a healthy economy, and this has forced the price of gilts up to an unsustainable level. The annuity providers need to make a profit from the costs of marketing and administering the policies, and so the expected return on annuities is much lower than that implied from the return on gilts alone.

While not doubting that an annuity income stream may form a useful part of pension provision it is an expensive option which is not well adapted to changes in the purchasing power of money.

An important consideration lies in holding diversified assets. Given the uncertain nature of the future no single company or asset class can be guaranteed as a store of wealth. But if we have any faith in the world then we believe that some of today's companies have a succesful place in tomorrow's world, and the pricing of some resources will serve as a store of value (viz gold, oil, agricultural products etc etc).. My strategy involves using a low cost SIPP envelope to hold a pool of diversified assets. Consider finding a place for investment trusts such as Alliance Trust (not a fantastic performer but a very long and relatively steady history), Ruffer (much younger, but with an impressive record in risk management and protection of value in adverse markets), ETFs such as ISF (ftse100), SLXX (UK Corporate bonds, probably the cheapest and most liquid way for a retail investor to hold a diversified position in this asset class) and such other assets that provide either strong income streams or hold a good possibility of capital growth, but without too much reliance upon any single element within the mix.

The maximum permitted levels of drawdown from a SIPP are probably a little higher than that consistent with safe planning. Opinions on how much it is prudent for a male in his mid 60s to draw down from savings on an annual basis range between 3% to 5% of total worth of disposable assets per anum. If income taken is adjusted following the fortunes of the fund, then all things being considered, the pensioner should be able to sustain a reasonably stable real income (with some inflation protection) for the rest of his life. He may also preserve a greater flexibility to respond to unforeseen contingencies (whether for unexpected medical costs or support to family members) than can ever be the case if he is entirely reliant upon annuities for income.

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lord lumsdale

May 27, 2012 at 09:33

This is all getting very complicated, having seen a 10% drop in my sipp fund over the last month (funds invested in India, China, Far east and UK equities).

I have run for the hills and moved the lot into cash until someone has the balls to put the fire out in Europe.

I guess it could have been worse I might have bought Facebook shares!

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DGL

May 28, 2012 at 09:39

IFAs can add value ! One year ago my IFA put a big lump of my SIPP into a Met Life fund which will return a minimum of 3% p.a. and a max of 10% (even if fund grows by more than 10%)... I know 3% is less than inflation... but given turmoil in markets of last 12 months..... I'm happy with that investment.

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Tortoise

Aug 24, 2012 at 09:22

It is time the whole situation with regard to annuities was looked at. According to the latest actuarial life tables a healthy 65 year old can expect to live another 17.8 years. At 6% p a that means you have to live to 82, your actuarial age of death, just to get your own money back. Factor in tax at 20% and that becomes nearly 87. This is just not acceptable. It is time that A) the requirement to buy an annuity was abolished without penalty. No 55% tax. B) GAD rates reflect equity dividend returns, not government bond returns and C) The government stops taxing pension annuity income as fully taxable and treats it like it really is, that is a return of your own money.

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