Why printing money is bad news for pensioners

Annuity rates are already low, but the government's decision to print new money will only make matters worse.

Quantitative easing - or printing money - is the government's latest measure to get the credit crunched economy going again. So, how does it work? Well, it doesn't actually involve printing truckloads of crisp new bank notes! In a nutshell, it means increasing the supply of money (electronically) to provide extra capital to the beleaguered banking system.

For a longer version of the theory, read this article.

There's no doubt quantitative easing is an extreme step. It's an alternative route for boosting the economy when base rate cuts don't appear to be working. And as we all know, with the base rate down to 0.5%, there's very little room left for manoeuvre there.

The trouble is no one really knows with any great certainty whether quantitative easing will put us on the road to economic recovery. But we can be pretty sure that it's not great news if you're about to retire.  

Why is quantitative easing bad news for pensioners?

The credit crunch has really played havoc with annuity rates. Level annuities convert your pension pot into an income stream when you retire, and provide the same fixed amount every year for the rest of your life. The prevailing rates when you buy an annuity will influence how high - or low - your pension income will be.

To begin with the credit crunch actually had a fairly positive impact on annuity rates, as I explained in this article. But this was only a temporary effect as annuity rates started to fall following a series of base rate cuts.

As if that wasn't bad enough, annuity rates look set to slide even further. And what's to blame this time? You guessed it...quantitative easing.

In simple terms, the supply of money has been increased because the Bank of England has bought a quantity of assets in exchange for cash. This includes buying gilts (government bonds) back from the banks, which should (hopefully) give the banking system the all-important cash injection it needs to start lending again.

Why is quantitative easing bad for annuity rates?

That sounds reasonable enough. But the problem is buying back gilts affects their value. Decreasing the supply of gilts - which happens when the Bank of England buys them back - will see the price go up. But this, in turn, means the gilt yield will fall. Why does that matter? Well, it's all to do with how annuity companies provide you with an income from your pension pot.

When you buy an annuity, you essentially sacrifice your pension fund to an annuity company. The company will then invest this cash in such a way that an income can be guaranteed to you for the rest of your life.

Among other assets, the annuity company will invest some of your money in government gilts. But because the yield on gilts is falling as a result of quantitative easing, the amount of pension income you'll get will also drop.

In other words, because the annuity company is earning less income from its assets than before, you'll also get less income when you buy an annuity.

Of course, this makes no difference to those of you who have already bought an annuity. It's only a concern if you're planning to retire now or in the near future.

What should you do if you're about to retire?

Today annuity rates are significantly lower than they were five or six years ago and quantitative easing will pull them down even further. That's why it's more important than ever to shop around for the most competitive annuity you can find.

This is called using the Open Market Option (OMO), and it really is one of the best ways to squeeze more out of your pension pot. Don't make the mistake of accepting the annuity you're offered by your pension provider, because the chances are it won't be the best.

The tables below shows the most competitive annuity companies on the market right now. (Note that the rates quoted are standard and are subject to change. The actual amount of income you might receive could be higher or lower.)

Best annuities for men age 65

Best annuities for women age 65

Source: The Annuity Bureau. Rates are based on a pension pot of £100,000 and provide a standard level annuity without guarantee.

The four best buys for men offer annuity rates between 7.2% and 7.49%. This means a pension pot of £100,000 will provide a gross annual income of £7,205 to £7,490. Meanwhile, because of longer life expectancy, rates will be lower for women at 6.81% to 6.97% (or £6,813 to £6,970).

This should give you a rough idea of what you can expect to get back from your pension fund. If the rates you are quoted by your pension provider are noticeably lower than those shown, then you'll know you haven't been offered the best deal, and you'll need to look elsewhere for a more generous rate.

There are plenty of things you can do to improve the income you get from your annuity. Find out more by reading How to buy the right annuity. And for the lowdown on using the OMO, take a look at Do this or lose 20% of your pension.

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