The Bank of England’s decision to cut the base rate to a record low of 0.25 per cent today (4 August) means it is now probably the “worst time ever” to consider buying an annuity, according to Aegon pensions director Steven Cameron.
It also spells more bad news for chronically under-funded defined benefit schemes, particularly those that have not put hedging strategies in place, as there will be more downward pressure on gilt yields, pension consultants have said.
Falling yields increase the amount of cash that sponsor companies have to put into DB schemes in order to pay out incomes to retirees, as well as hitting the amount of income retirees get when they exchange their pension pots for an annuity.
Mr Cameron stated: “The further cut in interest rates means now is probably the worst time ever to be making a retirement decision, with those buying an annuity today locking in to super-low returns for life.
“After seven years of low rates, there’s no guarantee we’ll see any significant improvement in interest rates or annuity terms in the short term. But those not ready to make a ‘once in a lifetime’ decision could consider deferring their retirement date or alternatively keeping their pension fund invested and drawing a retirement income direct from their fund.”
PwC partner Raj Mody told FTAdviser that while the base rate cut only applied directly to the rate at which the BoE lends to commercial banks overnight - meaning there was no “mechanical” connection between the base rate and gilt yields - it would nevertheless send a message to markets to expect all fixed income rates to remain “lower for longer”.
This sentiment would push gilt yields down from their already-record lows, he said, although the rate cut had been priced in by the market ahead of the announcement.
The lower-for-longer environment would be particularly bad for the DB schemes that had not hedged against further falls in gilt yield, Mr Mody added.
A recent study by PwC found around half of DB schemes had not hedged against further falls - a position that looked rational at the end of last year, when most economists were predicting the BoE would lift rates some time in 2016.
Charles Cowling, director of JLT Employee Benefits, said DB trustees that had not hedged now faced “the dilemma of whether to act now that prices have moved even further against them”, adding “the risky alternative is to stay in the investment casino and hope that markets are wrong and interest rates rise soon.”
Back to annuities, Intelligent Pensions head of pathways Andrew Pennie said the rate cut wasn’t necessarily a reason to avoid buying an annuity, questioning whether there was even room for annuity rates to fall any lower than they already are.
“For some people annuities are the right retirement solution and there is no advantage in deferring for several months – or years – in the hope that rates rise again,” he said.
james.fernyhough@ft.com
