Pension annuities offer a guaranteed income for the rest of your life – but did you know the stock market can affect whether you’ll get a great (or terrible) rate? If you buy at the wrong time, your retirement income could be significantly lower every year.
So, how does the stock market affect pensions – and what does it mean for your retirement options?
- Pensions and the stock market: the bad news
- What is an annuity?
- What are your pension options?
- Delaying retirement
- Lifetime annuities
- Investment-linked annuities
- Temporary annuities
- Income drawdown options
- Phased retirement
- Key rules to remember
Someone buying their annuity on a £100k pension at the start of 2019 would have an average income of £4,776. Just nine months later, the same pot would provide an income of £4,051. That’s £725 a year less!
Why is this?
Well, annuity rates are linked to bonds and gilts – meaning they’re linked to the stock market. As demand for gilts goes up, the yield rate goes down (because more people want them, so it’s less risky).
When this happens, annuity rates go down, too.
What Brexit does to the stock market
The pound surged immediately after the 2019 General Election – but within days it was back to pre-election levels. Uncertainty about Brexit means the stock market is fluctuating wildly with every new announcement about policies, trade deals, and possible new laws.
That means that, at the moment, the economic instability is causing chaos for anyone thinking of buying a pension annuity. You could get a great rate one week, but a terrible one a few weeks later.
The trouble is, you never know when the market is going to go up – or down – so it feels like a guessing game.
An annuity converts your pension fund into a guaranteed income. You hand over your pension pot savings to an insurance company, and in exchange they pay you a regular fixed income for the rest of your life.
If you live a long time, you can ‘beat’ the annuity. You’ll get more paid out to you over your lifetime than you paid into your pension. It’s like a reward for living longer.
However, if you die sooner than expected, you’ll not have got the best returns on your pension savings (and your family won’t inherit as much).
Enhanced annuities show the risk level providers take on giving you the annuity. They offer these for people with health problems, such as diabetes, or those who smoke. You’ll get a better rate on your income – because it’s likely you’ll die sooner than a healthy person!
In fact, as annuity providers change their mortality rates, their shareholders are receiving huge windfalls. Several years ago, mortality rates were set at a higher age – but people kept dying earlier than expected. This left huge amounts of the annuity investments in the hands of the providers.
For more in-depth information about how annuities work, check out what you can do with a £100,000 pension pot.
There’s no way to sugarcoat this: if you’re planning to retire in the next couple of years, you’ve been dealt a bad hand. Pensioners retiring today will see a lower income – and the very real threat of future inflation rises means the situation could get even worse.
You can compare your income potential with this free personalised calculator from the impartial Money Advice Service.
However, there are different types of annuities (as well as complete alternatives to them). So: what options do you have when securing a decent retirement income?
This isn’t a retirement option as such – but it is a very real alternative that shouldn’t be dismissed out of hand. There are a number of benefits:
- If you can continue working for a few more years, you might find that the market (and therefore the annuity rates on offer) improve
- There are tax benefits for working past State Pension age (such as not paying National Insurance)
- You’ll get extra pension money from the government in return for working longer
- You will be directly boosting your retirement income through work itself
For full details on the tax benefits of deferring your pension, click here.
This is what the majority of people do when looking to secure an income for their retirement.
With a lifetime annuity, you can only fix it once. You exchange the lump sum of money you’ve built up in return for a fixed income. You’re locked into that rate of pay for your whole retirement.
So, whenever you buy an annuity, the golden rule is to shop around. Rates vary hugely from one provider to another, which makes a big difference to your eventual retirement income. Never go straight for the deal offered by your pension provider: it’s your legal right to shop around for the best rates.
However, as discussed above, now isn’t the best of times to be buying an annuity, as rates are so low.
“The thing is, unless you buy an annuity with inflation proofing, the buying power of the income is sure to reduce over time,” warns Ray Black. “For some, it will make much more sense to consider an investment-linked annuity that at least has a chance of going up over time and may help to ward off the effects of rising prices over the longer term.”
Unlike conventional annuities, investment linked annuities don’t give you a fixed income – they provide you with an income that (hopefully) increases during your retirement.
As you will have guessed from the name, investment-linked annuities are linked to an investment – and as with any investment, it does contain an element of risk.
However, even the traditional ‘safe’ option of a normal annuity contains an element of risk. If you fix your annuity now (while rates are so low) you run the very real danger of your pension income being eaten away by future inflation rises, amongst other things.
You used to only be able to buy a lifetime annuity. Now, however, you could opt for a temporary annuity. This fixes your income for a short period – around five years is average.
At the end of the five years, you can decide what to do with what’s left in your pension pot. You might decide to then buy a lifetime annuity – or use a combination of lump sums and income drawdowns.
Income drawdown is different from an annuity. Instead of handing over your pension pot to an insurance company for a guaranteed income, you keep control of the money you’ve saved – and decide where to invest it yourself.
This is a riskier option than annuities (your income is not secure) and it’s only really a realistic prospect if you’re well-off – you’ll need enough in your pot to live off the rest of your life. It’s a realistic option for those with pension funds of £447,000 (to put that into perspective – the average pension pot is estimated to be around the 30-40k mark).
However, if you’re lucky enough to have that level of savings and you can afford to take on a bit more risk, it can certainly be worth considering.
Flexible Drawdowns and lump sums
You can manage your drawdown in a few ways. You can either take a regular sum from it and dwindle your pot – or take lump sums and invest.
Flexible drawdowns mean you can take your money as and when you want it. The first 25% of your pension pot is tax-free (either as a lump sum or as 25% of every regular payment, depending on your drawdown type). You pay basic-rate income tax on the rest.
The lump sums allow you to invest in other things, such as gilts, bonds, the stock market, even property. When your investment sums are significant enough, this can bring you a decent retirement income (such as on rental income from a property).
Of course, investments always come with the risk that you’ll not get back what you put in. However, look at it this way: you could get an annuity of 5% from a pensions provider – but that same provider is offering yields of 7% to shareholders thanks to that big windfall we mentioned earlier. It’s not guaranteed, of course – but you can see how investments could pay off!
Instead of converting your entire pension fund into an annuity or an income drawdown plan in one go, you can set up a number of annuities or drawdown arrangements by gradually drawing on your pension fund.
Such an arrangement means you can slowly convert parts of your pension fund into income while leaving the rest of it still invested (where, depending on future annuity rates, it may fetch you a higher income in later years).
A phased retirement plan also allows you to control the level of income you receive by choosing the number and timing of each annuity you purchase. This gives you the luxury of planning around your own financial circumstances (and the current state of the annuities market).
Finally, a phased retirement option can also be good for death benefits. If, upon your death, you still have an element of your pension fund that has not been converted into annuity payments, some of it may be payable to your beneficiaries. Any uncrystallised funds in a drawdown arrangement won’t face the hefty 55% ‘death tax charge’. Your spouse may be able to access your income drawdown arrangement, too.
Don’t forget the golden rule if you are purchasing an annuity: shop around for the best deal before you fix.
Also bear in mind that your financial circumstances are unique – the right retirement solution for you will depend on your personal circumstances. We therefore recommend you talk through your options with an independent adviser.
After all, how to provide for your retirement is one of the most important decisions you’ll make – so you want to be sure you’ve got a pension plan that’s right for you.