Annuities: Delaying can be costly
Despite their apparent poor value, delaying the purchase of a lifetime annuity is far from a straightforward decision, finds Bob Campion
The cost of borrowing is a variable that quietly governs the price of much in financial markets and business in general. But the borrowing cost for sovereign nations, normally a rather dull figure that rarely changes, has been making headlines across the world.
That has been particularly the case in Europe, where Italy flirted with the infamous 7% rate that had prefaced a bailout for its eurozone neighbour Greece. How the eurozone debt crisis will end is uncertain, but what has been clear is that despite the UK’s own economic woes, the markets seem increasingly keen to lend its prime minister, David Cameron, more money.
At the end of November, as European powers struggled to put together a coherent action plan to save the euro, the interest on UK gilts fell below the rate for German bunds, at 2.21% versus 2.3% for 10 year loans. Both rates will inevitably alter on speculation of the future of the eurozone and of the scale of the burden that is to fall on Germany, but the message is clear. The yield on UK gilts is at a historic low; not because the country is in such fine financial strength, but because it retains the ability to print money if it finds itself in difficulty.
Indeed, that is what the Bank of England did in October and November, increasing its asset purchase programme to £275bn through quantitative easing. At the beginning of December, the UK gilt yield had risen slightly off its low point to 2.3% on 10 year debt, but ultra low rates persisted throughout 2011. The indications are that financial markets have faith in the UK’s ability to pay its bills in the coming years relative to its economic peers.
But the Bank of England’s own purchase of a sizeable chunk of the Government’s debts – roughly a quarter of all gilts in issuance – has suppressed yields by as much as 1% according to estimates. There is no doubt that without quantitative easing and without economic crises in Europe and the US, the cost of borrowing for the UK would be far higher.
In 1980 the total amount of UK government debt was £71bn; in 2011 it reached £1,033bn, according to the Office for National Statistics. How long the UK’s economy, which grew by just 0.5% from July to September 2011, can support such hefty outstanding debts is the main outstanding questions for anyone with an interest in the gilt market.
Impact of falling yields
When it comes to retirement planning, the UK Government’s cost of borrowing is an acute issue. This is because insurance companies that provide annuities price the income that they are prepared to pay based on a margin above gilt yields, which is the lowest return they can secure for themselves without taking on financial risk.
Gilt yields have been in gradual decline since the onset of the financial crisis that started in the spring of 2007 when investors turned away from riskier markets in fits and starts. But the summer of 2011 saw a sharp fall. In July 2011, when 15 year gilts were yielding 3.9%, £100,000 would have bought a 2/3rd joint life annual annuity of £5,903, according to William Burrows of the Better Retirement Group.