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24 January 2013 last updated
Retirement annuities will benefit when the bond market crashes

As the UK economy and equities improve investors will seek higher returns moving funds from the over inflated bond market to other investments reducing prices and increasing yields to benefit retirement annuities in the UK.

Two years ago gilt yields reached a high for that year with the 15-year gilt yield at 4.15% compared to current levels of only 2.53% and as annuity rates are primarily based on this yield income from annuities has decreased.

For a 65 year old with a fund of £100,000 a pension annuity for a single life, level basis has reduced 18.4% from £6,590 pa to only £5,373 pa, an all time low.

As the US economy continues to improve there will come a point where inflationary factors tip the scale resulting in a bond crash similar to that last experienced in 1994 where US 30-year Treasury notes increased by 240 basis points over a nine month period which would mean yields on UK gilts would also increase.

Retirement annuities benefit with bond market crash
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Bond prices fall from their high point

Investors in Treasury notes and government bonds such as 15-year gilt yields are usually institutional investors such as pension and investment funds, annuity providers, companies and countries securing income for a specific period of time. The Rise in the price on bonds and gilts has occurred due to the uncertainty over the world economy including the Eurozone and gilts have been used as a safe haven against a volatile global economy.

The 15-year gilt yields reached an all time low of 2.02% in August 2012 which means the demand for bonds and the price reached a high. Retirement annuities also reduced to match this fall at this time.

Yields have since recovered to 2.53% as various threats have been resolved, at least in the short term, such as the Eurozone pledged to do "whatever it takes" to support the euro and sovereign debts of member countries and the deal reached over the US fiscal cliff. In the UK the Bank of England has stopped using Quantitative Easing which currently stands at £375 billion making this less likely in the future which as a mechanism tended to force yields lower.

Annuity income 16% higher if bonds crash

Any change in current prices is likely to begin in the US as their economy recovers to more normal growth rates and inflation which would reverse the past seven year trend with $600 billion flowing out of equities and $800 billion flowing into bonds. This reversal is referred to as the great rotation with bond investments flowing out into equities.

Retirement annuities reached an all time low in January 2013 and have reduced further than the level of gilts due to the EU Gender Directive introducing Unisex annuity rates. This gender neutral pricing was an opportunity for providers to reduce annuities as pensioners panicked buying annuities before the deadline of 21 December 2012.

Gilt yields could return to levels two years ago which would mean a 162 basis point rise and annuity rates could increase by 16.2%. This could happen very quickly and investors shift from bonds to equities, such as with a year. As an example a 65 year old male or female with a fund of £100,000 could buy a single life, level annuity for £5,373 pa and after the bond market crash this could increase by £870 pa to £6,243 pa.

For a male the difference over his lifetime would be the annual gain multiplied by his life expectancy at this age of 17.8 years according to the Office of National Statistics (ONS) or extra annuity income of £15,486. For a female she would be expected to live for 20.4 years so over her lifetime the extra annuity income would be £17,748.

When will the bond crash happen

The bond bubble has been around for the last two years and analyst have been warning about the impending collapse of the bond market although this depends on the recovery of the global economy. With the Eurozone remaining in a poor condition with high unemployment and recession, the US grappling with the growing $16.4 trillion of debt and China growth slowing not to mention the UK nearing a tripple dip recession, it seems unlikely that the moment is now.

Pensioners in the next two years may find retirement annuities are very similar in terms of income when they make their decisions. One alternative to the conventional annuity would be a fixed term annuity which would allow an individual to receive an income in the shorter term and receive a guaranteed maturity fund at the end of a specified term of between 5 and 25 years. This would offer an income in the short term and the opportunity to select a lifetime annuity from the open market option later when annuity rates may have increased.

If they suffered from a lifestyle medical condition during this time such as high blood pressure, Cholesterol, are a smoker or are overweight an enhanced annuity could offer more income. If they had more serious health conditions such as diabetes, heart conditions or cancer an impaired annuity could offer 40% more income.

News related stories:
Current annuity rates may increase with no QE stimulus proposed
Annuity rates January 2013 lower but increases expected
Pension annuity income and equities rise after fiscal cliff deal
Related internet links:
Telegraph - Bank of America issues 'bond crash' alert
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