The annuity market makes depressing reading for retired people who are looking to convert a pension into income. Rates have been low for the past few years and experts predict that the downward trend will continue for a while yet.

The average return for a 60-year-old with a pension pot of £10,000 is currently £622 a year, down from £833 ten years ago. The reasons for the fall are twofold: a fall in long-term gilt yields, which are linked to annuities, and a rise in longevity.

Suzanne Greener, of Investment, Life & Pensions Moneyfacts, the specialist magazine, says: “From 1994 to 2003 there is evidence of the prolonged double whammy on annuity rates of falling long-term gilt rates combined with significant adjustments to reflect the impact of improving mortality rates.”

Despite the disappointing returns, investors stand to make a lot of extra cash by choosing carefully when they buy an annuity. However, Hargreaves Lansdown, the independent financial adviser, says that only four out of ten investors shop around on the open market for an annuity, known as the open market option. The other 60 per cent choose to stick with their pension provider, missing out on additional income of about 10 per cent.

Nigel Callaghan, a pensions analyst at Hargreaves Lansdown, says: “Do not rely on your existing pension company to give you a reasonable deal – lots don’t. Many insurers are cynically preying on consumer confusion and apathy by offering substandard annuity rates at retirement. By simply comparing prices, you could give yourself up to a 60 per cent pay rise for the rest of your life.”

About 40 per cent of the newly retired are also missing out because they could be eligible for an impaired-life annuity, resulting in rates up to 60 per cent higher than those on standard annuities. As life companies grapple for a competitive edge, even illnesses that seem low-grade can result in a substantial uplift to the annuity rate. For instance, an investor with diabetes can receive about 60 per cent more than one who is in perfect health.

Mr Callaghan says that insurers, who are desperate to steal a march on their competitors, are offering better and better rates to people who have health problems, effectively neglecting healthier older people because they are less profitable. The result could be that conventional annuity rates become even less competitive.

“The market is at a tipping point,” Mr Callaghan says. “There are 400,000 people due to retire this year and their incomes in retirement could vary dramatically, creating a kind of annuity inequality.”

Many insurers, including Legal & General, Norwich Union, Scottish Widows and AXA, offer enhanced rates for people with health problems as well as conventional rates. Others, such as Standard Life, offer only standard annuities, while one, Just Retirement, deals only with customers who have health problems.

Making the right decision is crucial because investors cannot change their annuity once it has been purchased. Mr Callaghan adds: “If someone purchases an annuity at 60 and develops an illness a few years later, then he or she will have missed out on the enhanced rates.”

However, waiting a few years before taking out an annuity carries the risk that rates will fall further. The Financial Services Authority recommends that people start thinking about what sort of annuity they want four months before they retire.

Rates can also vary according to postcode – Legal & General recently announced better rates for customers who live in poorer areas – and whether you buy a single or joint-life annuity.

A joint-life annuity, which will continue to pay a percentage of income to a spouse on death, will offer lower rates because the insurer will be paying out for longer. However, you can obtain higher rates by choosing a lower percentage of income for the surviving spouse.

CASE STUDY

Colin Peach, of Middlesbrough, recently bought an enhanced annuity with his £180,000 pension pot.

The 61-year-old, left, worked for an offshore oil company until having prostate cancer diagnosed, with the cancer having spread into his lymph nodes. Mr Peach will now receive an annual income 50 per cent higher than he would have obtained from his Norwich Union annuity if he had been in good health. He also took 25 per cent of his pension pot as a tax-free lump-sum.

Mr Peach, who recently finished radiotherapy treatment and is now undergoing homoeopathy, says: “It is fingers-crossed time for me at the moment. I had been thinking about returning to work, but under the circumstances I have decided to enjoy life to the full.”

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