The latest range of bailout and economy stimulation measured announced by the UK government, we will see an initial fall in UK tax revenue, which may increase further if the recession bites badly. The government plans to fund its action with an unprecedented level of national debt. The Government will be forced to borrow heavily to finance the bailout of the banks plus these tax breaks.

They will have to do this by issuing a very large number of government bonds, known as gilts, with a potential knock-on effect for long-term interest rates. Annuity rates are broadly related to interest rates, so falls in interest rates normally results in annuity rates also fall.

Traditionally insurance companies hold gilts to match their annuity liabilities. Gilt yields have been falling over the past two decades as inflation has dropped and longevity has increased. After a short spell of increasing inflation the big fear now is falling prices and hence falling interest rates.

Not all annuity companies rely solely on gilts, and it is not unusual for insurers to hold a proportion of corporate bonds or other fixed interest investments as well, which have a similar structure to government gilts although they are more risky as companies are more likely to go bankrupt. Some insurers hold property assets as well, although that also carries risks, such as illiquidity particularly in times of recession and economy contraction.

The higher level of risk between government bonds and corporate bonds is generally reflected in the interest rate, or 'coupon', with companies having to pay a higher rate to raise capital than the Government.

The gap between the yields has been widening significantly over recent months, reflecting the increasing risk of default in corporate bonds as more companies are going to the wall. As we saw with the massive bailout of banks, even financial institutions previously perceived as safe can no longer be considered safe. On most measures corporate bonds are looking remarkably cheap for investors willing to take a measured risk, and could be an attractive alternative to cash as interest rates continue falling.

The level of gilt issuance in the current fiscal year is expected to rise to almost double the level in the last financial year. Anyone approaching retirement with a money purchase pension pot with a high exposure to fixed income securities such as gilts or corporate bonds may do quite well over the next year or two, as short-term demand will push prices up. Conversely the yields will fall, as these are fixed-income securities, and as they do annuity rates will follow suit.

So what should you do if you are approaching retirement? If you are in a public sector scheme then you have very little to worry about, at least so far as your accrued pension entitlement is concerned. Public sector pension benefits are already guaranteed by the Government, and any liabilities will be ultimately met by taxpayers, with an ever increasing cost.

If you are in a private sector final salary scheme then changes in long-term interest rates will not affect your benefit entitlement, but could result in this not being fully met as a result of the increased strain on the financial viability of the scheme itself. However, the pressure on schemes could be alleviated if new gilt issues include an adequate supply of long-dated bonds in the 30 to 50-year range.

Investors with the biggest headache are those in money purchase schemes who are due to retire within the next two years. Some may face the double whammy of a downturn in their fund values and falling annuity rates. Equity markets will recover, but the big question for anyone coming up to retirement is how long will that take?

One option would be to delay retirement. Investors who have cash reserves may want to consider delaying their pension and living off their reserves for as long as possible.

Investors who don't have cash to fall back on but hold other types of investments should take advice on how best to combine their pension and non-pension assets. It might be better, for example, to switch to a more flexible pension arrangement, such as a phased drawdown plan or income drawdown plan, that will allow benefits to be drawn gradually while delaying the purchase of an annuity.

These arrangements are not suitable for everyone and specialist advice is essential. Please contact Annuity Arrow and we will arrange for you to receive impartial advice from an Independent Financial Advisor (IFA).