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5 August 2013 last updated
UK annuities boost as Fed plan to taper QE to start from September

Annuities have been given a boost as Federal Reserve moves closer to tapering QE after unemployment falls last month which would mean lower bond prices and an increase in yields from September.

The US Fed is currently buying $85 billion of bonds and mortgage debt per month with the stimulus package until the level of unemployment reduces.

Annuity rates are primarily based on the 15-year gilt yields and tapering of US bond purchases would reduce the price and increase the yield thereby increasing income from annuities.

The stimulus has been providing liquidity fueling higher equity and bond markets creating a bubble and recent announcements by the Fed to stop Quantitative Easing (QE) from July 2014 resulted in large falls.

The Fed has subsequently reassured the markets that QE would continue until US unemployment reduced from the current 7.4% of employment to 7.0%, closer to the level in 2008 before the financial crisis.

Uk annuities boost if Fed tapers QE
  Gilt yields recovery after Fed plan to taper stimulus sees 6% increases for annuity rates
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Annuities up strongly by 6% as gilt yields rise

Over the past three months the 15-year gilt yields have increased 71 basis points from 2.22% to 2.93% at the end of July. As a general rule this would mean pension annuity rates would increase by 7.1% although on average they are up 5.96% suggesting over this time period they could increase a further 1.14%.

Over six months standard rates are higher by 8.22% but yields are up by only 33 basis points suggesting rates could go down, however, providers may not be too concerned as they know US Federal Reserve stimulus will be tapered and then stopped in the long term.

The figures are similar for smoker and enhanced annuities that are higher by 7.65% over three months, a bit more than yields, and are 8.48% higher over six months. Standard annuity providers have been more aggressive in the third quarter when compared to impaired providers although competition have increased since the beginning of the year.

US Fed prepares for tapering as things improve

The level of unemployment has reduced to the lowest level for four years with another 160,000 new jobs created bringing unemployment down to 7.4%. In addition figures have also shown that the US economic growth has accelerated with an annualised rate of 1.7% in the second quarter up from 1.1% for the first quarter.

Since the programme started in September 2012 the Fed now owns 20% of US Treasuries and 25% of mortgage-backed securities. The stimulus package has also helped to lower long term interest rates which has contributed to the improvement in economic growth. The Fed would not consider increasing interest rates until unemployment was 6.5%.

People buying UK annuities should be prepared for volatility in the equity markets if the Federal Reserve does start tapering from September. Many people remain invested right up to the point they buy their annuity and it is possible their pension fund could fall by 10% once the first tapering occurs.

To protect against this fall they should convert their fund to cash within their pension to avoid the risk of volatility. On the other hand tapering would see gilt yields increase leading to higher annuity rates and this could occur in the third quarter of this year.

News related stories:
Retirement annuities threat as yields fall on UK and US stimulus plans
Pension annuity boost as equities and yields up with US jobs data
Annuity income and equities reduce as Fed plans to stop stimulus
UK annuity income 7.7% lower as US Federal Reserve considers stimulus
Related internet links:
BBC - Federal Reserve sees pick up in US growth
Guardian - US jobless figure drops to lowest rate in four years
Telegraph - Fed should taper QE in September
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