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20 September 2013 last updated
Annuity Rates stabilise as US Fed delays tapering stimulus

UK annuity rates will stop increasing as the US Federal Reserve decides to delay a plan to taper the stimulus package and continued buying of bonds and gilts will see prices rise and yields fall.

The Dow Jones index initially increased 147 points to 15,677 after the surprise announcement by Federal Reserve Chairman Ben Bernanke not to initiate tapering of stimulus.

Currently the package buys $85 billion of bonds and mortgage debt per month and will continue until unemployment reduces to 7%.

Annuity rates are primarily based on the 15-year gilt yields and currently yields are 3.31% after starting the month at 3.15%. This 16 basis point change in yields will at some point result in a 1.6% change in annuities.

The markets had expected the US Quantitative Easing (QE) to be reduced, however, the Federal Reserve has stated that unemployment remained elevated even though economic data is improving and has delayed tapering in the short term.

Annuity rates stabilise as tapering delayed
  As stimulus tapering is delayed annuity rates are likely to remain level or even fall in the short term
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What next for people retiring and taking benefits

Equity and bond markets have now priced in a $10 billion tapering of the current $85 billion a month stimulus. For the bond markets this has seen prices fall and yields increase so now the US Fed is delaying the cut until the end of the year or beginning of next year this could mean yields will start to fall slightly. Gilt yields reduced yesterday by 8 basis points to 3.28% but only recovered 3 basis point today.

Standard annuity rates are more resilient to changes and may remain at current levels for two or three weeks. For enhanced annuities a fall in yields will see an immediate decrease in rates as providers are sensitive to changes in this market. People that suffer from medical conditions can expect a slight reduction in their their life expectancy and receive higher annuity income.

For conditions such as smoking, being overweight, a heavy drinker, suffering from high blood pressure and Cholesterol increases of 18% could be expected. For more serious conditions such as diabetes, heart condition or cancers enhancements of up to 40% are possible.

Many people remain invested right up to the time they take their benefits and already the gains made after the US Fed's announcement have been eliminated as the Dow Jones reduces by 225 points to 15,451. Market confusion over Ben Bernanke could mean a gradual fall in equities in the short term. For people retiring now they should consider converting their fund to cash to avoid any sudden fall in their pension fund value and if may take up to a month to transfer to an open market option.

US Fed has more measures looking ahead

Global markets still look to the US for future direction and as this become clear we will see a reversal of the past seven year trend where $600 billion flowed out of equities and $800 billion flowed into bonds. This 'great rotation' would see bond investments flowing out into equities which has been triggered with the announcement of tapering by the Fed.

Timing for the Fed will depend on the US economic recovery which is not as strong as it should be. The Fed has two measures it can use, firstly the rate it reduces the $85 billion a month stimulus and secondly the point where it becomes zero which is the targeted level of unemployment, currently 7%.

The problem with the level of unemployment is the falling headline rate as people stop looking for work and it is unclear if this is structural where there is a change in the type of skills required in the economy or because more stimulus is required. The Fed may decide to change the target level for unemployment to a lower figure such as 6.5% allowing more time for stimulus to run and for tapering to occur without panicking the markets.

Currently it seems the gains from annuities, up 12.5% and 25.6% when combined with gains in equities during the first half of the year are likely to stabilise or reduce slightly for the rest of the year. There is still the expectation of the 'great rotation' but as things stand this has been delayed to next year.

News related stories:
UK annuities boost as Fed plan to taper QE to start from September
Retirement annuities threat as yields fall on UK and US stimulus plans
Annuity income and equities reduce as Fed plans to stop stimulus
UK annuity income 7.7% lower as US Federal Reserve considers stimulus
Retirement annuities will benefit when the bond market crashes
Related internet links:
Guardian - Federal Reserve maintains stimulus
BBC - Shares hit record high as Fed refrains from tapering
Telegraph - Fed surprises market by delaying tapering
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