Over 55? Looking to buy an annuity? Best not complain about the price to a Remain voter. Since the result of the UK referendum on EU membership came out on Friday morning, the yield on UK gilts (government bonds) has fallen significantly – by the end of Friday it had hit a record low of 1.01% and by the middle of Monday it had shocked the markets by moving under 1%. That’s nice in one way: it suggests that even in the midst of Brexit hysteria, the world still sees our government debt as a safe-haven investment. But it comes with problems too.
Annuities are priced from gilt yields: buy one this week for £100,000 (assuming you are a healthy 65-year-old) and it will give you £150 less a year in income than it would have last week. That’s unlikely to be the end of it. UK interest rates are much less likely to rise now than they were – and there is a reasonable chance that the base rate, gilt yields and hence annuity rates will fall further from here.
The good news is that no one actually has to buy an annuity. You can instead shift your pension into drawdown – keeping your money invested and draw it down as needed. This comes with its own risks, of course: see here for more on the market volatility of the last week and the obvious risks to your capital.
But hanging on might still feel more comfortable than swapping £100,000 in capital for an income of a mere £5,000-odd (without inflation protection). Note that the average dividend yield on stocks in the FTSE 100 is still around 4%. This isn’t a simple decision – even those dividends could be cut. But if you do want to get an annuity in the near future, the message is simple: do it fast and make sure that you seriously shop around along the way. As Holly Mackay of Boring Money puts it, “get your skates on and get that quote” (quotes are usually valid for two to four weeks after you get them).
Those with defined-benefit (DB) pensions might be feeling a little smug at this point – after all, on the face of it stock-market gyrations mean nothing to them. They shouldn’t be. The plunge in yields could well have repercussions for them too. Most fund trustees calculate their future liabilities with reference to gilt yields: the lower yields go the higher those liabilities go. The result?
The hole in the UK’s combined DB pension funds rose to a record £900bn last Friday. That matters for the simple reason that funds that know they can’t meet the promises made to pensioners will call for more funds from their sponsoring companies. If those companies can’t come up with the goods, pension payouts will end up taking the pain – just as they are likely to at BHS and at Tata Steel.