Pension income could drop 20% under new EU laws

Retirement income from annuities could drop as new European Union laws force firms to switch to less risky investments.

Insurers tend to invest a large chunk of their annuity cash in to corporate bonds, but the new rules will steer them towards government bonds and cash.

Although annuities are no longer compulsory for retirement savers with pension funds in the UK, many still opt to buy an annuity with their pension pots.

An annuity is a financial contract that generates a regular income.

Insurers look towards corporate bonds to underpin their annuities as they tend to offer better yields than British gilts or US treasuries.

Consultancy firm Deloitte reckon the change would cost a retirement saver between 5% and 20% of their pension income.

A 60-year-old male pensioner with a £100,000 pension fund could lose between £300 and £1,100 a year as a result of the changes.

Richard Baddon, insurance partner at Deloitte, said: “There has been a great deal of technical debate and negotiation with the EU about Solvency II. A focus for the UK has been the treatment of the ‘matching adjustment’, which affects annuities and the way insurers set reserves and calculate capital.

“The amount that annuity rates will fall by depends on whether there is a favourable outcome to negotiations around the matching adjustment. In any event, insurers may need to change the way they invest their assets and may move away from corporate bonds, which give a higher return, to lower-yielding government bonds.”

Annuity rates are also likely to be affected by the European Union gender pricing ruling that makes insurance companies quote the same rates for financial services for men and women.

The industry predicts annuity income may fall by 8% or so for men, but rise by up to 25% for women.