Why this is a good time to retire

Money Talk
By Billy Burrows
William Burrows Annuities

Purchasing an annuity can be a complex exercise Billy Burrows, William Burrows Annuities

You may not realise it, but if you have been saving in a personal pension policy, or you are in a money-purchase scheme run by your employer, then now is a relatively good time to retire.

The reason is that two trends are running in your direction - annuity rates have been rising, and pension fund values have been going up too.

It is these two factors which will determine how much income you will get from your personal pension fund.

This means that if you retire at a time when annuity rates are low and the value of your pension fund is lower than expected, you will end up with a lower pension than if you retire at a time when annuity rates are higher and the value of your pension fund is high.

Timing

Unfortunately it is difficult to get the timing of your annuity decision right.

Take for example the situation earlier this year.

In February 2008, pension funds that were invested in equities had fallen by about 6% since August 2007 and annuity rates were down by about 1%.

However, by June 2008 the stock market was only 3% down compared with August 2007 and annuity rates had risen by more than 5% since last August.

This means that somebody retiring today would get nearly 9% more pension compared with someone retiring in February 2008 if they had remained invested in equities throughout the period.

As both annuities and the stock market are going up it might make sense for investors to lock into these gains and secure their incomes by purchasing annuities.

Going up

But before rushing out to buy an annuity you should ask what has caused annuity rates to rise?

Timing is key to improving your retirement income

Annuities are priced in relation to the yield on long dated gilts and corporate bonds, and also with reference to life expectancy tables.

Until recently yields had been falling for a number of reasons, but the main factors are supply and demand, increased life expectancy and the benign outlook for inflation.

The demand for bonds has been strong as large investors including pension funds have increased their holding of fixed interest investments.

And at times of uncertainty in stock markets there is often a flight to quality which results in a switch away from equities to bonds which results in lower yields.

The increase in life expectancy may be slowing down, but continued improvements in medical science suggests that, despite the younger generations' "happy go lucky" lifestyles, people will be living longer in the future.

Furthermore the increased sale of "enhanced" annuities, for those people in poor health, means that the benefit of the mortality cross subsidy for standard annuities is reducing because those with below-average life expectancy are being removed from the annuity pool.

Inflation

One of the main reasons why annuity rates are rising now is because the concern about higher rates of inflation in the future translates into higher bond yields.

Most people can maximise their income at retirement by following a few simple rules

However, if inflation continues to increase, the purchasing power of annuities will be eroded and those on fixed incomes will suffer.

There are concerns that the official index for inflation, the Retail Prices Index (RPI), which is still used for annuities, does not reflect pensioners' real inflation.

"What is the point of paying the high price of an index-linked annuity if it does not keep up with personal inflation" you might ask?

Given the choice, more and more people are choosing level annuities in preference to escalating annuities.

This is hardly surprising when the difference between the starting incomes can be as high as 30%.

But there is a fear that the low take up of escalating annuities will cause problems in the future if the cost of living for pensioners continues to increase so rapidly.

Decision

In conclusion, purchasing an annuity can be a complex exercise because it is important not only to select the right options but it is also important to get the timing right.

Unfortunately many people have little control over the timing of their annuity purchase because when they retire they need a pension.

But most people can maximise their income at retirement by following a few simple rules.

The first is to consider investing in safer investments such as fixed interest in the run up to retirement.

This safeguards against a sudden fall in equity prices as happened in early 2008.

Do not fall into the trap of putting off an annuity purchase in the hope that rates will improve.

There is an "opportunity cost" in deferring an annuity purchase as income forgone in the deferral period is rarely made up by higher payments in the future.

And if you have a large enough pension fund consider purchasing your annuities in stages.

Phasing your annuity purchase may improve your overall annuity income and provides more flexibility.

Meanwhile, do not ignore the effects of inflation: it will not go away.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.