With the Bank of England slashing rates left, right and centre, savers and pensioners would be forgiven for thinking they had seen the worst, but the latest move by the government could spell disaster for those about to purchase an annuity.

The latest meeting of the Monetary Policy Committee not only brought another 0.5 per cent base rate cut, but also revealed intentions to inject £75 billion into the economy by buying government and corporate bonds.

This policy – known as ‘quantitative easing’ – aims to increase the amount of deposits in the banking system so that, by way of deposit multiplication, they can increase the money supply by increasing debt (i.e. lending).

Those that specialise in pensions advice,  however, are expressing alarm at the government’s plans. They are worried about the impact that the injection of up to £150 billion of newly created cash into the economy could have on annuities.

Behind the scenes
The inner workings of annuities are quite simple. Insurance companies pay out a regular income from a retiree’s pensions pot based on the yields generated by government bonds or gilts.

The most recent peak for annuity rates was last summer, with rates reaching a six-year high. This meant that a pension pot of £100,000 would have fetched an annual income of around £7,920.

But not even annuity rates can defy gravity. As we all know, everything that goes up must also come down, and over the past few months annuity rates have been steadily falling – something that had been widely predicted for some time.

But the government’s introduction of quantitative easing has sent this downward spiral into overdrive, with four of the major annuity providers slashing their rates in the week following the announcement.

Here comes the science…
The reason that quantitative easing has already had such a monumental impact on annuity rates is simple. The cash injection caused the price of gilts to surge, leading to lower yields and therefore lower pension annuity rates. And while insurance companies would have benefited from a capital gain, as asset prices have been pushed up, it is the ongoing yield that determines annuity rates.

For those approaching retirement, this news is not good. But there are a few steps that you can take to make sure that your income doesn’t take too much of a hit. According to Nick Flynn, director of retirement planning at The Retirement Adviser, investors should never buy the in-house annuity on offer from an insurer without first shopping around for a better rate.

‘Exercising your right to an open-market option (OMO) can increase your annuity rate by as much as 20 per cent. For example, an investor with a pension fund of just £10,000 who doesn’t take advantage of the OMO to find out what is available could lose up to £530 from their total income.’

Diversifying your annuity
For many, buying an annuity now in order to crystallise any investment losses within a pension fund might not be the most suitable option given the current climate. There is another way.

It may come as a surprise to those about to buy an annuity that, even though you have to purchase one before reaching the age of 75, you don’t actually have to use all of your pension pot to do so.

Nigel Callaghan, pensions adviser at Hargreaves Lansdown, suggests that people preparing to retire soon should consider splitting up their pension pot and spending some of it now and some later on annuities.

The benefit is that, firstly, you can hedge against annuity rates because in a couple of years time they could be on their way back up again and, secondly, the longer you leave the money invested in the stock market, the greater the chance of benefiting from any increase in value.

The most important message, however, when it comes to purchasing an annuity is
to stop and think twice before locking your pension fund into an annuity rate. It is a once-in-a-lifetime purchase, which cannot be undone at a later stage.