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NAOMI CAINE and SIMON BAIN
The rates on standard annuities have dipped by 3.13% since March and by 14% over the past three years, according to the latest figures from MGM Advantage.
A 65-year-old man with a £50,000 pension fund who bought an annuity in 2009 could expect an annual income of £3323. Now, he would receive an average of £2737, a drop of £586 a year.
The rates for men are likely to drop further in December, when an EU ruling forces firms to offer unisex rates.
But there are ways to fight back. People who search the market for the best rate can make a big difference to their retirement income. The top annuity rate would secure a pension income of £2970 a year for a 65-year-old man with a £50,000 fund. The lowest would generate an annual income of £2464, a difference of £506. Graeme Mitchell, managing director of Lowland Financial, an independent financial adviser, says: "There is not enough awareness of the open market option – and pension companies do not make it easy enough for people to exercise their right to search the open market. But 99 times out of 100 you can do better by shopping around."
The type of annuity you choose can affect your income, too. A level annuity pays a set income for life. The rates on level annuities tend to be higher at the outset, but they do not take into account the effects of inflation.
If you want your pension income to rise along with the cost of living, you should choose an index linked or escalating annuity. But the decision is not easy. Andrew Tully at MGM Advantage says: "Escalating annuities are a hard sell at the moment because they pay less in the early years. You also need to live well into your 80s before the escalating annuity would make up the lost income.
"It all depends on your life expectancy and your attitude to inflation, but I would edge towards a level annuity in the current market."
For example, the average annuity would currently pay £2737, compared with £1348 for an escalating annuity at 5%.
You can also expect a smaller retirement income if you make provision for your spouse, with an average rate of £2416 if you include spouse's benefit.
More people are turning to investment linked annuities, which pay a guaranteed income, but offer the chance to increase income by keeping some of the pension fund invested.
It sounds like a win-win situation, but the higher income is not guaranteed and depends on the performance of the underlying investments.
Mr Tully says: "Investment-linked annuities are undoubtedly more risky and are not suitable for everybody. However, they can be a good choice, particularly for people with bigger pension funds and alternative sources of income."
However, Mr Mitchell says: "If you are willing to take an investment risk with your pension income, why not go straight into a drawdown plan, which gives you greater freedom?"
In a drawdown plan, your money is invested and you draw an income from the fund, within limits each year. When you buy an annuity, you hand over your money to the pension firm, which works well if you live for a long time, but not if you die after a few years and your family gets nothing. For example, you could pay £50,000 for an annual income of £2737. Someone who lives for 30 years gets a good deal. But the figures are not so great if you live only for five years.
Drawdown is different. If there is any money left in your fund when you die you can leave it to your family, though it will be taxed at a flat rate of 55%.
But – and it's a big but – drawdown is risky. Mr Mitchell says: "No-one should go into a drawdown plan unless they fully understand the risks involved. They should also have a pension fund of at least £100,000, as well as income from other sources, such as Isas."
Mr Tully says: "People spend hours choosing the right mobile phone, but are not willing to take the time to consider their annuity options. But it's a decision that could affect your income for 30 years."
Is the Bank of England to blame for falling pensioner incomes?
Annuity rates are closely linked to the yields on Government gilts. But when the BoE pumps money into the economy through quantitative easing (QE), it buys up Government gilts, so pushing down the returns.
Dr Ros Altmann, the director-general of Saga, said: "The Bank says increases in pension fund investments have offset the fall in annuity income caused by lower gilt yields. This is not the real-world experience of most people coming up to retirement."
However, Laith Khalaf at Hargreaves Landsown said: "Most pension savers will be invested in a lifestyle fund as they approach retirement, which invests in bonds and gilts. The average lifestyle fund has risen by 51% since March 2009, over this time annuity rates have fallen by 21%."
Malcolm McLean, of Barnett Waddingham, an actuarial consultant, said: "Annuity rates have been in decline for over 20 years, largely as a result of increasing life expectancies, but the credit crunch and subsequent recession have accelerated this trend by causing falls in interest rates and yields from Government gilts.
"I cannot see that this trend is likely to reverse any time soon and, in fact, it looks like low annuity rates are here to stay."
Ill heath does not often give you an advantage, but if you are a smoker or suffer from a medical condition you can often get a higher rate with an enhanced or impaired annuity.
For example, an income of £2737 on a conventional annuity could rise to £3290. That combined with shopping around delivered a huge 24% increase in her pension for Christina Fairbairn, a retired catering manager from Wishaw, North Lanarkshire. She took advantage of the free annuity advice service offered by Nationwide, and found that had she not explored the open market option, she would have been almost 20% worse off by talking the annuity offered automatically by her pension company Standard Life.
Mrs Fairbairn says: "Nationwide worked all the figures out and kept us up to date. We had to wait almost three months in the end, but that wasn't their fault."
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