Record annuity rise boosts British pensions

2013 saw a strong surge in pension annuity rates, raising pension incomes for the first time since 2007.

Some good news for those saving for retirement or close to giving up work: pension annuity rates surged strongly in 2013, giving retirees extra bang for their bucks

In fact, the rate increase seen last year was the highest on record, according to researchers at Investment Life and Pensions Moneyfacts, which has been monitoring annuity rates since 1994. Following 2013's boost, annuity rates have now reached their highest levels since June 2012.

In short, annuity rates recorded their largest increase in two decades in 2013, bringing much-needed relief for hard-pressed pensioners and others seeking guaranteed incomes.

A record year for annuity rates

According to Moneyfacts, the record rise in annuity rates in 2013 was the first yearly increase since 2007, before the global financial crisis rocked world markets. However, retirees should not become complacent, as there is still a huge gap between the best and worst 'open market option' (OMO) annuity rates.

Moneyfacts identified two reasons for this big boost to annuity rates in 2013.

The first is higher gilt yields. Gilts – UK government bonds – make up almost all of the UK's national debt of £1.23 trillion. As fixed-income investments, when bond prices are high, yields (similar to the yearly interest rate from savings) are low, and vice versa.

In 2013, bond prices fell as investors, encouraged by recovering growth, sold bonds to buy riskier assets such as shares. During 2013, yields on 15-year gilts soared, rising from 2.31% at the start of 2013 to 3.42% by the end. In other words, the yield on the gilt typically associated with annuities rose by 1.11% percentage points, soaring by almost half (48%).

Second, last year saw a return to a more competitive pricing environment as annuity providers (mainly large, well-known insurance companies) intensified competition. In their efforts to win new customers, many providers repeatedly raised annuity rates during 2013, so as to secure places in best buy tables.

When European law – the EU Gender Directive – forced insurers to move to gender-neutral pricing in December 2012, the majority of annuity providers took a very conservative attitude towards rates. As a result, annuity rates fell to an all-time low in March 2013. However, after these first few months of declines, rates began bouncing back last spring, as providers fine-tuned their pricing strategies to win more business.

This more competitive market for annuities is seen in the percentage difference in rates offered between the five most aggressive standard annuity providers. This spread narrowed from 12.2% at the start of 2013 to a mere 2.7% by the end of the year.

Retirees rejoice as rates rise

While all annuity providers lifted their rates in 2013, some pushed through double-digit uplifts. For example, Hodge Lifetime lifted its rates most aggressively, up by more than a sixth (17.3%), with Legal & General (+13.9%) and SAGA (+13.9%) hot on its heels.

Although competition was red-hot at the top end of the annuity market, rates rose far less at the least-competitive end of the spectrum. Among the three least-competitive annuity providers at the start of 2013, only Prudential (+13.7%) made a larger-than-average increase to its rates.

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Choose your annuity with great care

With annuity rates rising by double digits last year, plus the UK stock market returning around 18% in 2013, last year was a terrific one for investors, especially those saving for retirement. However, Moneyfacts has warned workers and pensioners not to rest easy, because continued uncertainty surrounding the global economy means that gilt yields remain volatile.

That said, if the UK and global economies continue to strengthen in 2014, then we could see another round of annuity rate rises, as more and more providers stop erring on the side of caution and hike their rates in order to compete.

What's more, with cut-throat competition at the top end of the annuity market, it is vital that would-be annuitants shop around for the very best rates. With some providers still lagging hopelessly behind the best buy providers, choosing the wrong annuity provider could be one decision that costs you thousands.

Clearly, after five consecutive years of decreasing annuity rates (including an 11.5% slump in 2012), securing a comfortable retirement income has become a terribly tough task. Today, annuity incomes are more than a third (36%) lower than 15 years ago and over a fifth (21%) lower than five years ago.

Therefore, anyone considering swapping their pension pot for an annuity simply must shop around – ideally by enlisting the help of a top annuity broker. With this expert help, you could end up with a pension income more than a sixth higher, as the gap between the highest and lowest open-market rates currently stands at 17.4%. Also, if you have health problems that would qualify you for an enhanced annuity, then an annuity broker can find you the best returns.

Show me the (extra) money!

As an example of the bigger payouts to be had from higher annuities, let's look at a 65-year-old retiring at age 65 with a pension pot worth £50,000 and choosing a standard/level/without-guarantee annuity.

The average yearly income on offer from this pension pot started 2013 at £2,615 and ended the year at £2,892. This increase of £277 (a rise of 10.5%) adds up to an extra £5,540 over 20 years – one valuable bonus not to be missed.

On the other hand, the above is an average annuity income, so let's look at the best and worst payouts on offer.

Currently, the market-leading annuity would provide an annual income of £3,057 from the above £50,000 pot. At the other end of the scale, the worst annuity would generate just £2,602 a year. Over two decades, this yearly difference between the best and worst rates (£455) adds up to a mighty £9,100.

In summary, to stay smart, always shop around for an annuity before turning your pension pot into a lifetime income. Otherwise, even with rates rising, wide variations in pricing could mean you lose out on a small fortune in extra income!

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More on annuities and retirement:

How to make sure you have enough money in retirement

How to buy an annuity

Why a flat annuity beats an inflation-linked annuity

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