Don't Rush When Choosing Your Annuity

It’s one of the most important financial decisions people make, but few seek out the best option.

These are not good times to retire, with savings rates at historic lows. People relying on their pensions may have had nasty shocks as stock market falls, resulting from the credit crunch and recession, have eaten into retirement savings. There seems to be a few positives, and this is especially true for those who have reached retirement and are looking to exchange their pension pot for an annuity, in effect an income for life. Annuity rates, the amount of regular income savers can get for their savings, have bombed of late, not least because of the Government’s programme of quantitative easing. The process, which involved the government buying back its own gilts, has led to a 50-year low in gilt yields. Insurance companies, which base their annuity pay rates on these gilts, have been cutting back. With this is mind, the strategy must be to maximise your annuity returns for your pension pot. Unfortunately, people generally spend little time choosing their annuity and those that get it wrong could pay dearly.

How Annuities Work

Annuities essentially work by exchanging pension money for a secure income. An abundance of annuity types are available, but most advisers warn against taking out an annuity with your pension provider. Instead, it is best to take what is known as the “open market option” and scan the deals on offer from a variety of providers. The Financial Conduct Authority (FCA) says this can increase your income by as much as a third.

A Conventional Annuity

A conventional, or level, annuity guarantees a fixed income until you die. This security comes at a price, as the pension fund will not be passed on to the estate upon death. Couples may decide to take out a joint life annuity. Although single life annuities pay a higher level of income than joint life annuities, payments stop when the holder dies. A joint life annuity will continue to pay out for the remaining partner, but may be at a reduced rate. Please be aware that a level annuity will be eroded by inflation over time.

Guarantee Period

Another annuity option that provides some protection is to add a guarantee period. This means that income payments will continue to be made to your estate for a set period of time, even if you die within that period. Without these add-ons, all income payments stop upon death and the insurance company reaps the benefits.

Escalating Annuity

Individuals can also choose to arrange their annuities so that they receive an amount that grows year on year. These escalating annuities can be set to increase by a fixed amount, say, 3% per year or by the Retail Price Index. However, inflation-linked annuities tend to be more expensive and start off paying a lower amount, typically between 30 and 40% less.

Enhanced Annuity

These are another way to maximise returns. They pay a higher rate of return for those with medical conditions or lifestyle conditions which might reduce life expectancy. For serious medical conditions, there are “impaired life annuities” which pay a considerably higher income for individuals with a low life expectancy.

With Profits

Income levels from a with-profits annuity are linked to the performance of the insurance company’s with-profits fund. An individual who opts for a with-profits annuity product must set an anticipated bonus rate (ABR). This is then used to set the income level. Income is based on the providers’ with-profits fund and so will either grow or fall depending on performance. As with all with-profits annuities, if the fund suffers, payments shrink.

Investment Linked

Those willing to take chances can opt for an investment-linked or unit-linked annuity. These potentially offer better returns in the long run, but management charges can be hefty and the annuity income paid is based on the ups and downs of the stock market.

Limited Period Annuity

A limited period annuity may be a better option for those who wish to ride out the recession. These last for five years, after which you can switch to a new annuity.

Value Protected Annuity

Value protected annuities, (also known as capital protected annuities) are relatively new and were introduced in April 2006. The aim of this value protection is to provide a return of any unpaid income in the event of death before age 75. Levels and bases of, and reliefs from, taxation are subject to change To discuss how you can get the most out of your retirement planning, please contact us for further information