The increase in average life expectancy is great news for all of us, but the main challenge is that it makes funding our retirement considerably more expensive. Unfortunately the problem is compounded by the low annuity rates that are the traditional way of generating a pension, with a fund of £100,000 only buying a 65-year-old an annual inflation-linked income of £3,165.
An annuity is an insurance contract that pays a fixed or rising level of income for the rest of the purchaser’s life. Until the new pension freedoms were introduced in April 2015, most people with a defined contribution pension – where your income depends on how much you save – had little option but to use the money they had accumulated to buy one of these products.
Before the financial crisis this wasn’t a huge problem because the annuity rates, which are linked to 15-year government bond yields, were fairly reasonable. For example, in September 2007, a pension fund of £100,000 would have bought a 65-year old a single life, level annuity of just under £7,500 per annum. This has since fallen to £5,120.
Annuities that increase in line with inflation are even more expensive, but they are often the better option given the length of time that some of us will have to rely on the income. A pension fund of £100,000 would currently buy a 65-year old a single life, RPI linked annuity with a five-year guarantee of just £3,165….