Pension savers to lose out from interest rate rise but pensioners could get income boost

Bank of England: Victoria Scholar discusses interest rates

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The Bank of England will meet to discuss interest rates on November 4, prompting speculation that an increase could be in store. If interest rates do rise, it will create significant winners and losers among people looking to save for retirement or maximise their pension income.

A potentially negative aspect of a rise in interest rates could be that pension savers might see the value of their pension funds fall. When interest rates rise, bond prices commonly fall.

Pension savers could also be impacted if they are hoping to transfer their final salary pension. Rates for people transferring their pension may be lower as a result of an increased interest rate.

Rising interest rates could mean a tightening of purse strings for Britons, which could make financial planning and the accumulation of wealth more difficult as people have less money. This may ultimately mean people making lower pension contributions

Higher interest rates could make it easier for people to get into debt, making saving for retirement even harder.

However, an interest rate rise could be welcome news for those looking to purchase an annuity in retirement. Purchasing an annuity means swapping pension savings for a guaranteed income for life.

Annuity rates recently hit a two-year high, with a 65-year-old with a £100,000 pension being able to get an income of £5,099. This is up from £5,000 in October 2019.

Annuity rates had been in long-term decline and hit rock bottom in 2016. They are based primarily on 15 year-gilt-yields which have reduced since the financial crisis, though there has been an improvement this year.

Helen Morrissey, senior pension and retirement analyst at Hargreaves Lansdown believes an increase to interest rates could provide additional income for those purchasing an annuity.

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She said: “After years in the doldrums, annuity rates have been on the rise throughout 2021, and recently hit a two-year high. If the Bank of England chooses to raise interest rates this could give annuities a much-needed further boost towards the end of the year. At a time when pensioners missed out on an inflation busting state pension increase this extra income is particularly welcome.

“While the increases we’ve seen lately may only seem small – an extra £99 per year for a 65-year-old with a £100,000 pot – over the course of a retirement this extra cash mounts up.

“Those who decide to annuitise later get even more benefit, with a 70-year-old getting an extra £102 per year and a 75-year-old getting an extra £157. Including more information around your health and lifestyle will likely result in further increases in income.

“With an interest rate rise likely on the cards soon it’s worth shopping around to make sure you get the best deal possible.

“If you’re worried about getting the timing right, and rates rising after you’ve locked in an income, remember that you don’t have to annuitise all at once.

“You can buy an annuity with part of your pension pot in order to make sure the essentials are covered, and then when you’re older and possibly qualify for a better rate, you can consider buying another annuity with another slice of your pension pot.”

Ms Morrissey also explained how interest rates impact annuities and why this is important.

She said: “Providers use Government bonds to provide annuity income. When interest rates are low, lots of investors pile into these bonds because the return on cash is so low, so the price of Government bonds rises.

“Given that they produce a fixed income, the income as a proportion of the price falls (which is known as the yield falling). It essentially makes it more expensive to buy an income, so annuity rates drop.”

“When interest rates rise, investors can make a higher return elsewhere, so they sell out of government bonds. This makes the price fall and the yield rise. It’s therefore cheaper to buy an income, so annuity rates tend to rise.”

However, Ms Morrissey advised that annuities may not be for everyone, and encouraged those interested to find the best deal for them.

She said: “Annuities are just one retirement income option. They pay out an income for life which may rise in line with inflation. Once you decide to purchase an annuity you cannot reverse it. Consider whether this works for you or if a more flexible option such an income drawdown might suit your needs better.

“Shop around for the right annuity. Don’t just accept the first annuity quote you receive as different providers can offer different rates. It is always worth shopping around to get the best deal for you.”

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