Interest rate rises lift annuities

Post by Mearns & Company in News

It is not only bank interest rates which are on the up.

So far 2022 has been a year of rising interest rates in most of the developed world. The central banks of the UK, US and Eurozone all began the year with their main rates close to zero, and it seems likely that they will still be on an upward trajectory into 2023.

While the focus has been on base rate increases, and the knock-on effect on savings and mortgages, other interest rates have also been getting higher. For example, the yields on medium and long-term government bonds (UK gilts), corporate bonds and other fixed interest securities have all increased. Conversely their prices have fallen – yields and prices move in opposite directions.

One neglected sector has benefited markedly from the fall in bond prices: annuities. For any given age, the annuity rates that insurance companies can offer are largely determined by what they can earn by investing in long-term bonds. In this instance, as bond yields go up, so too do annuity rates. The change has been greater than expected.

For example, at the end of last year, the yield on the 15-year gilt was 1.15%, whereas by late July it was almost 2.50%. Take a level annuity rate for a 65-year-old, for instance. By late July, the top rate was around 6.25% compared with 5% at the beginning of the year. This amounts to an increase in guaranteed income of a quarter. Similar rises apply at other ages, although the greatest impact is at younger ages.

Index-linked annuity rates have also improved, but they remain a high-end option. At 65 the current rate is 3.45%. This starting rate is quite a lot lower than a level annuity but consider what index-linking means at a time when inflation is forecast to exceed 11% by October 2022.

The jump in annuity rates has coincided with a bad first half for many of the world’s investment markets. The combination has served as a reminder that, although flexi-access drawdown is currently the most popular method of drawing an income from a pension fund, it is not the only option and it comes with built-in investment risk. An annuity provides certainty, regardless of investment conditions or how long you live.

To find out the level of income an annuity could provide for you, please ask us for a personalised illustration.

The value of your investment and the income from it can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit with your overall attitude to risk and financial circumstances.