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28 December 2012 last updated
Annuities income reduce as equities fall with fiscal cliff deadlock

Markets are losing confidence in a deal to avert the fiscal cliff to be implemented in January as the negotiations are deadlocked resulting in lower fund values and reduced annuities income for retiring pensioners.

From the 1 January 2013 the fiscal cliff will force the US to accept $600 billion of spending cuts and tax rises unless a deal can be reached between President Obama and Republican House of Representatives.

The slow moving negotiations risk missing the deadline which could increase unemployment up from the current 7.9% level and push the US back into recession.

Equity markets are nervous as US growth would have a significant impact on the world economy with Wall Streets Dow Jones index reducing 413 points from 13,351 ten days ago to 12,938. For UK pensioner portfolios exposed to American markets they will find their fund has reduced in value and this would lower the income from their pension annuity.

US Fiscal Cliff annuity income
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Differences between the deal makers

The differences are focused on the scale of taxes where Mr Obama has reduced his offer from $1.6 trillion to £1.2 trillion over ten years which is closer to the Republican House of Representatives position of $1 trillion. Mr Obama has also offered to increase the level at which the taxes will impact on US citizens from those earning $250,000 or more increasing this limit to $400,000 whereas the House speaker has been considering a level of $1 million.

The Republican controlled House of Representatives are opposed to tax cuts and would prefer the Democrats to reduce public spending such as the healthcare and welfare benefits scheme introduced under President Obama.

Impact on pensioner annuity income

Income in retirement depends on the value of the pension fund and annuity rates at that time. Uncertainty in the markets would mean equity markets falling and as the vast majority of pensioners remain invested right up to the time they take their benefits, the fiscal cliff would see a reduction in their fund values. This would mean less money to purchase an annuity so a 5% fall in equities could mean a 5% fall in the the fund and therefore the annuity income.

Gilt yields are also affected by market confidence. Annuity rates are primarily based on the 15-year gilt yields and as a general rule a 10 basis point fall in yields would translate to a 1.0% fall in annuities. As confidence falls investors become nervous about future risk and will move their funds to safe havens such as US Treasury notes, German Bunds or UK government gilts. Higher demand for gilts will push up the price and reduce the yield which in turn will reduce rates and the income from annuities.

If a deal can be reached it is likely that equities will increase and investors will feel more confident to invest in higher risk areas so gilt yields would also increase. The combined higher pension fund values and annuity rates would be a bonus for people retiring in the first quarter of 2013 after a year where annuity income has reduced for standard rates by as much as 12% and smoker and impaired annuity rates by as much as 15% since March 2012.

News related stories:
UK annuity income from pension funds boosted by fiscal cliff offer
Retirement annuity income kept high with Federal Reserve stimulus
Pension annuity income and markets lower with US fiscal cliff
Pension annuity income lower as market falls after poor US earnings
Related internet links:
Guardian - Obama urges action on new fiscal cliff deal
BBC - Obama optimistic on fiscal cliff deal
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