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Today it’s hard to find anyone outside the public sector who can still pay into a final salary pension.
Try asking around your wider friend group. I’ve found one, and even he is being transferred from ‘defined benefit’ to the far more common ‘defined contribution’ pension.
Like the rest of us, he will now be required to pay money into a pot, along with employer contributions, and hope it grows to a size that will cover his full retirement. The final salary pension already accrued will make that significantly easier.
Final salary pensions were treasured for many reasons. Firstly, you knew the retirement salary you’d get, as the name suggests. Secondly, that income would rise with inflation.
Final salary ‘lite’
Imagine if such a pension product was available today, and available to all. Well, there is. But it’s not loved. In fact, it’s very much unloved. I am talking, of course, about
You hand over money to an insurance company and they will pay you an agreed income each month or year. On an annuity rate of 6.5%, you’d pay £100,000 and get £6,500 a year. You can add inflation protection, so the income rises with inflation. But it will start at a far lower level. Like a final salary pension, you know what you’ll get throughout retirement and you know that it will rise with inflation.
Yet the pariah status of annuities remains alive and well. It was hit home at a recent panel discussion where I was talking about early retirement. My fellow panellist delivered a brutal valedictory on the wrongs of annuities, met by many audience nods.
History explains why. Before 2015, most of us were compelled to buy an annuity with our pensions. Hence the celebrations when compulsion was removed for all, enabling us to go out and “buy Lamborghinis”, if we so wanted (a dry comment from the pensions minster at the time, Steve Webb). We didn’t and haven’t. But we had the choice.
Meanwhile, the anti-annuity sentiment gathered pace. Annuity rates, which were already low at the time, fell even further. This is because annuity pricing is led by the government’s cost of borrowing. As this fell throughout the 2010s so did the income that an annuity could buy.
The renaissance of annuities
But fast forward to today and much is changing. It began when the Liz Truss’s mini budget of 2022 sent government borrowing rates soaring, and therefore annuity rates. The purchasing power of £100,000 for a 65-year-old, without inflation protection, suddenly surged from an annual income of around £5,000 to around £7,500. Some shrewd buyers picked up a bargain, buying certain income that might exceed uncertain returns of the stock market – a rare opportunity.
Industry figures point to a renaissance in the popularity of annuities as rates have improved. Sales rose 39% in the last financial year, according to figures recently published by the Financial Conduct Authority.
Rates may be about to rise further due to moves in gilt pricing. The crucial 15-year gilt yield, which influences annuity pricing, has risen from a whisker above 4% three weeks ago to around 4.5%. The chart below shows the longer history of the 15-year gilt yield.
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