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7 October 2013 last updated
Best annuity rates from Legal & General reduce 2.3% as gilt yields fall

Legal & General have reduced their best annuity rates by 2.3% after the rapid fall in gilt yields last month after the Federal Reserve and US debt ceiling forced investors to move funds to safe havens.

Annuity rates are primarily based on the 15-year gilt yields which reduced from a high of 3.38% to close at 3.09% last month.

As a general rule a 29 basis point fall would mean annuity rates will reduce by 2.9%. Standard annuity rates did follow yields to lower levels immediately and as a result were exposed to future falls.

The fall in yields followed an unexpected delay in the tapering of the $85 billion a month stimulus package which should have been tapered from September by the Federal Reserve.

There had been a rise in yields as investors moved funds out of bonds and gilts ahead of the decision and this delay left the market confused about the future direction which started a buy back of bonds forcing yields lower ahead of the debt ceiling crisis.

Best annuity rates 2.3% lower
  Legal & General reduce annuity rates by 2.3% following falls in gilt yields after US debt ceiling crisis
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Annuity rates fall 2.3% lowering annuity income

Providers of enhanced annuities were quick to reduce margins as the events unfolded so by the start of October were only slightly off the gilt yield decreases. Standard annuity providers were still increasing their rates in opposition to the decreases which has resulted in the sizable fall of 2.3%.

Our benchmark example for a 65 year old and a fund of £100,000 buying a single life, level annuity has reduced from a two year high of £6,159 pa to £6,019 pa. This £140 pa fall is significant as over a lifetime the income will be lower. The Office of National Statistics (ONS) would expect a male to live for 17.3 years and he will receive £2,422 less during his lifetime. For a female she can expected to live for 20.4 years and her income will reduce by £2,856.

The following chart shows how standard annuities with different features such as single or joint life, level or escalating changed last month with an average increase of 2.28%.

Standard rates actual changes
Fig 1: Change to standard annuities compared to gilt yields

The 15-year gilt yields were lower for that month by 7 basis points but the sudden fall in the last week leaves providers exposed. As a result the likely outcome can be seen in the following chart.

Standard rates expected changes
Fig 2: Expected change to standard annuities

On average pension annuity rates are expected to fall by 2.98% although escalating rates are more exposed than level. With Legal & General reducing their rates

US debt ceiling likely to be resolved

The other factor forcing yields lower has been the US debt ceiling crisis where The US Government and Republican run House of Representatives need to agree to increase the borrowing cap or risk a serious threat to global financial security as the US may default on it's Treasury notes for the first time in history.

The debt ceiling of $16.7 trillion was reached in May and the US embarked on a series of "extraordinary measures" to extend the time before it runs out of money on 17 October. Assuming a deal is reached to extend the debt ceiling to next year, investors will regain confidence and return to the Federal Reserve stimulus package and the likely tapering plans.

People retiring now could wait a couple of weeks and see annuity rates recover slightly as it is likely that gilt yields will bounce up once the immediate threat of the US debt ceiling is resolved.

News related stories:
UK annuity threat as yields fall with looming US debt ceiling
Annuity Rates stabilise as US Fed delays tapering stimulus
Enhanced annuities rise 1.5% after strong gains in gilt yields
Latest annuity rates improve 1.5% but Syria action could reverse gains
Related internet links:
Guardian - US Treasury warns Congress on debt ceiling
BBC - US to hit debt ceiling by October
Telegraph - America to hit debt ceiling by October
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