The decrease of annuity rates due to Quantitative Easing would be in addition to the 11% decrease already experienced by pensioners since June 2011 due to the Eurozone crisis where investments have been moved to safe havens such as UK government bonds or gilts.
Gilt yields fall when demand for gilts increases and as prices increase it reduces the yield which means the return on those assets falls. Annuity providers use 15-year gilts to secure the income for pensioners and as a general rule a 60 basis point reduction in gilt yields will result in a 6% decrease in annuity rates, although there may be a time lag before the changes are implemented by the providers.
Quantitative Easing (QE) was introduced in March 2009 and had the effect of reducing annuity rates by 6% during that year. QE was initiated as a result of the financial crisis requiring the Bank of England to inject money directly into the economy and they are doing this now to meet the Monetary Policy Committee inflation target of 2%. The other method to achieve this target is by setting the bank Rate which is very low at 0.5% and therefore Quantitative Easing is the only way to meet the inflation target.
At the end of 2011 inflation, such as the Retail Price Index (RPI) fell from 4.8% to 4.2% and if this continues to fall at 0.6% per month it is likely to fall below the inflation target of 2%. Therefore the Bank of England is planning to inject £75 billion from February 2012 onwards and possibly up to £100 billion more during the year if required.
The Bank of England intends to use Quantitative Easing to stimulate consumer spending and company investment. By buying government bonds or gilts the overall effect is to reduce the yield so encourage investors to switch from bonds or gilts to other financial assets such as company bonds which in turn will reduce the yield on these assets. This ultimately is expected to reduce the cost of borrowing for both the consumer and business and encourage spending due to the extra money in the economy which will help to increase inflation to meet the 2% target.
Quantitative Easing also has consequences for defined benefit or final salary schemes provided by employers as gilts are used to determine the future funding provisions for these schemes. As the yields decrease a company may find the final salary scheme deficit increases and therefore the company will at some stage need provide extra funds for the pension scheme rather than using these funds for other investments such as employing new people.
The bank of England is using QE to benefit the wider economy but the side effect will be decreasing annuity rates for pensioners that are already suffering from lower incomes due to increasing inflation and QE will further reduce their buying power during their lifetime. To counter these negative factors pensioners can maximise their income if they have medical conditions which could add 20% to 60% to the annuity rate by purchasing an impaired health annuity.
Colin Thorburn is the founder of sharingpensions.co.uk and for expert information about the latest annuity rates and planning for retirement please visit http://www.sharingpensions.co.uk/annuity_rates.htm.
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