Annuity rates hit their lowest level since 1994 in September, with implications for those making retirement decisions.

Since the introduction of pensions flexibility in 2015, annuities have become much less popular as a way of converting a pension fund into income. The most recent figures from the Financial Conduct Authority show that over five times as much money is placed in income draw down now as goes towards annuity purchase.

Now annuity rates have been back in the news, with several press reports citing calculations from the Money facts comparison website that rates had hit their lowest level in 25 years. According to the data, a 65-year-old purchasing an ordinary pension annuity, with no increases in payment and no minimum payment period, could expect to receive just 4.1% – £410 a year per £10,000 of investment. That was a significant drop from the start of 2019, when an extra £58 a year was on offer.

In the short term, the cause of the annuity rate decline has been the drop in long-term interest rates since January. For example, the yield on a 15-year UK government bond fell from 1.56% at the start of the year to 0.86% by mid-September. This fall in long-term rates has been a global phenomenon, resulting in negative interest rates spreading to many international bond markets.

The longer term fall in annuity rates also reflects declining interest rates, which have been on a multi-decade downward path. In addition, increased life expectancy has put downward pressure on annuity rates, although this effect has receded latterly as recent statistics have suggested life expectancy improvements are flat lining.

The preference for draw down, however, comes with investment and mortality risks – investment returns may be below expectations and/or you may outlive your pension pot. If nothing else, the annuity rate can provide a benchmark against which to consider the rate of income withdrawals.

If you are approaching retirement, make sure you take advice before dismissing annuities completely, especially if you are risk averse or will have few other sources of retirement income.

If you are some way from retirement, remember that 4.1% figure when you think about how much you want to contribute to your pension. After all, at 4.1% a £25,000 pension annuity – with no inflation protection or spouse’s benefits – will cost about £610,000…

The value of your investment 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.

The value of tax reliefs depends on your individual circumstances.

The contents of this article is for information purposes only and represent the opinion of Pryor Portfolio Management Limited only. No action should be taken on the basis of this article alone. We always recommend you seek more detailed independent financial advice before taking action – feel free to contact us at any time.