Until recently the interest rate on gilts has been very low. This has made annuities a relatively expensive product for annuity providers to fund.
As a result, annuity rates have been on the low side in recent years – comparatively speaking when looking back 25-30 years ago.
However, in the past 12 months the interest rate on gilts has been rising, resulting in higher annuity rates.
In late September and early October there were some particularly sharp increases.
This can, in part, be attributed to financial markets having less confidence that the government at the time could be relied on to pay back the money they borrow, says Mark Ormston, director of propositions and corporate partnerships at Retirement Line.
Annuity providers back the annuities they sell by buying long-term gilts. As long-term gilt yields increase, so too do annuity rates.
The concern surrounding the UK’s ability to repay its debts and ensure the recovery of the economy – worsened by the "mini" Budget – contributed heavily towards the rise.
Ormston says: “This is why a risk premium is sometimes built into these interest rates – an extra cost to the government when borrowing money for the fear that risk was being taken with the public finances.”
But when Jeremy Hunt was made chancellor, gilt rates started to fall slightly, which also happened when Rishi Sunak became the prime minister.
Ormston says: “The markets took the view that the grown-ups were now in charge. However, even with this taken into account, gilts are still much higher than they were at the start of the year.”
Lorna Shah, managing director of retail retirement at Legal & General Retail, says: “Despite annuities becoming more popular, I do think there is more awareness needed of the flexibility of fixed-term annuities and the benefits of enhanced annuities.
"People are still surprised at the payments that can be gained from a wide range of medical conditions, for example diabetes, or just from lifestyle choices like smoking and drinking."
It is difficult to predict exactly how long gilts will remain at this level.
Interest rates
However one gauge, Ormston notes, might be for as long as the Bank of England keeps interest rates high as they attempt to tackle inflation.
He says: “With this in mind, we may well see annuity rates maintain at or near their current level for a while yet. As a result, we may see many retirees looking to lock in some secure income via an annuity while rates are high and annuity providers compete in a busy market.”
David Gibb, chartered financial planner at Quilter, says: “It is difficult to predict exactly when annuity rates will peak. While it is unlikely they will continue to rise by much more, there is still a possibility that they could depending on the BoE’s actions moving forward and, more importantly, how the markets react to the Autumn Statement.”
