Rate cut could spell trouble for annuities

As with any other financial instrument whose fate depends on interest rate movements, calling trends in the annuity market has been a difficult business for commentators over the past two years. While the moment of peak rates had an obvious catalyst, forecasting their downward trajectory is proving pretty difficult.

As the chart below shows, annuity rates peaked around the time of the fated Liz Truss mini-Budget in 2022 but have had more gentle ups and downs since, based on markets’ rate expectations. Overall, this year they have stayed higher than first expected, in line with a base rate that has (contrary to initial expectations) only just been lowered by the Bank of England (BoE).

Could this be about to change? The BoE cut rates on 1 August, and the rise in equity market volatility around the same time has accelerated the recent fall in gilt yields. Henrietta Grimston, financial planning director at Evelyn Partners, notes that the UK’s 15-year gilt yield, regarded as a major determinant of annuity rates, fell as low as 4.07 per cent last week, having been as high as 4.67 per cent as recently as June. “That is likely to hit annuity rates in the short to medium term, after the incomes on offer to retirees had risen strongly in 2023 and remained high in 2024,” she adds.

She notes that annuity rates have held up better than expected this year as rate cuts were delayed due to persistent inflation and wage growth; but following the BoE move “they will probably fall, and those considering an annuity might want to act fairly swiftly”.

However, initially the drop shouldn’t be too extreme. Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, also expects annuity rates to start coming down, and says this could be “a sign to those who have delayed their annuity purchase to take the plunge in the coming months”. But she also notes: “It is fair to say the Bank of England will not slash rates at anywhere near the same speed at which they hiked them.” 

Annuities can make a lot of sense in certain circumstances, particularly if you do not qualify for the full state pension and would like a secure income as a basic building block of your retirement strategy. But they have various drawbacks compared to drawdown, chiefly the lack of flexibility and the fact that unless you purchase extra protection, they end on your death. Additionally, the real value of the income they generate is eroded by inflation, unless you opt for an expensive escalating annuity. If you do decide to look past these downsides, it would make sense to act some time soon, when rates are still as attractive as they are likely to get in the near future.