What is an Annuity
An annuity is a secure regular income usually paid for the rest of your life, which is normally built up via a pension plan throughout your working life. The annuity is the regular income that is bought with your pension fund at retirement.
Once set up, the annuity is normally fixed and offers a secure income for the rest of your life, although there are options to fixing the income, for example you could have an increasing income via an indexed linked annuity.
The amount of pension income you receive from the annuity will be dependent upon your age, whether you are male or female, the size of your pension fund and even other circumstances, such as the state of your health or previous occupations. As there are various options to select for your annuity, it is always a prudent idea to seek advice.
Are they flexible?
In the main no! The majority of annuities purchased cannot be altered, surrendered for cash or transferred. This makes it absolutely essential to choose the options that suit your circumstances best. So when you are ready to convert your retirement fund into an income via an annuity take some time to consider the options available.
What options are available if I decide to take an Annuity?
Single life annuities - this annuity will pay only to the person named in the annuity and once they die the annuity payments (income) stop. There is no provision for remaining partners or dependents. If you do have financial dependents, you really do need to consider what they will live on after you die and the annuity has ended.
Joint life annuities - this option means the annuity pays its income until the annuitant (purchaser) dies, it then carries on paying to a named partner or dependent for the rest of their life too, usually at a reduced rate.
Level annuities - will pay the same fixed amount each month for the rest of your life.
'Escalating' or index-linked annuities - here the income paid will increase by a fixed percentage (e.g. 3% or 5%) or alternatively by the rate of inflation each year. This type of annuity pays much less at the start, but the income in the later years of your life will be higher in real terms than for level annuities.
Should you have no other protection against inflation, it would be important to consider the benefits of an escalating annuity. Alternatively, some consider the lower starting income of less value, but it is important to remember that around 3% inflation per annum can have the effect of halving the real value of your income within 20 years or so.
Guarantee period - Annuity companies typically offer a five-year guarantee period on your income, this means if you were to die within five years of buying the annuity, the company will still carry on paying your income to your estate upto the fifth anniversary. However, you can select upto a maximum 10-year guarantee period, this has the effect of reducing the income slightly, compared to the five year guarantee.
'Impaired life' or 'enhanced rate' annuities - If you are a smoker, have a history of illness, you could obtain a higher annuity income. Some insurance companies will pay a higher income if you have certain medical conditions. Statistics show that people with some health conditions have a shorter than average life expectancy. These specialist insurers use this to your advantage: they will pay you a higher income because they calculate that, on average, your income should be paid out for a shorter period of time.
Investment linked annuities - The income you receive will depend upon the performance of the chosen investment markets. A proportion of your pension fund remains invested, in products like unit trusts, investment bonds or with profits funds, in the hope that the eventual payouts will be higher later in your retirement, but this is not guaranteed. These may not be suitable for you if you don't want to take any further investment risk.
Income drawdown - This option is not an annuity. It allows you to continue investing your pension fund whilst taking some income out. Again, this carries investment risk, and will typically have higher charges. Income Drawdown will not be suitable for all customers. Unlike an annuity there is no guarantee that an income will be paid for life. Withdrawals may erode the pension fund and annuity rates may be lower in the future, leading to a reduced level or loss of retirement income.
The value of investment income from them can fall as well as rise and you may not get back the full amount invested.(See below).
Do I have to buy one?
No, not necessarily. Many of the pension rules governing retirement were changed on the 6th April 2006 (A Day), previous rules governing Pensions dictated that Annuities had to be purchased by age 75. However, the government announced that the old rules would be relaxed from April 2011 onwards
What are the alternatives?
Unsecured Pension (USP)
(also known as Pension Fund Withdrawal or Capped Drawdown
USP are an alternative to buying an annuity but come with some restrictions attached. Income can be between zero and 120% of the income that would have been provided from an annuity. The option to come out of ASP to buy an annuity is available at any time.
Anyone can use USP, however, some pension schemes will not operate USPs for small funds (Â£50,000 or less). If you are in an occupational money purchase scheme you may be able to use a USP, if the scheme rules allow it. If you are in an employer's scheme that doesn't offer a USP and you want to use it, you must first transfer your pension rights from that scheme into a personal pension scheme. In this case you may find that you could lose any protected entitlement to a tax free cash sum greater than 25% of the fund value. As always it's a good idea to take advice. Currently the remaining pension fund must be used to secure a pension income by the age of 75.
Alternatively Secured Pension (ASP)
When the age of 75 is attained the remaining balance of the fund can be used to buy an annuity or ASP. ASP is similar to USP but with the following differences:
The upper limit of what can be withdrawn as income is about 90% of a level single-life lifetime annuity, the lower limit is 55%. This is reviewed on an annual basis.
The funds in ASP are invested in a similar way to a USP arrangement and are therefore subject to investment risk. You are able convert your ASP into a lifetime annuity at any time.
Should death occur, whilst in ASP, any remaining invested fund can either be used to:
Provide for a spouse, civil partner or dependant’s ASP for someone over age 75, or
Provide for a spouse, civil partner or dependant’s USP for someone under age 75, or
Provide a pension annuity for a spouse, civil partner or dependant, or
Provide for a charity lump sum death benefit, or
Provide for a transfer lump sum death benefit (where there is no surviving dependant).
Where remaining funds are subsequently used for the benefit of a spouse, or civil partner, or dependant, then there will be no immediate charge to Inheritance Tax (IHT). However, if on the subsequent death of that person there are still unused funds remaining, those unused funds will be taxed for IHT as if they had formed part of the original pensioner’s estate on death.
Depending on how the original unused funds are used by any spouse, civil partner or dependant, there could be a further tax charge imposed on the net remaining funds after IHT has been paid.
A Transfer Lump Sum Death Benefit paid to a charity will not attract IHT.
The responsibility for paying any IHT liability rests with the pension scheme administrator. This means that the tax liability can be paid directly from the unused funds.
Levels and bases of and reliefs from taxation are subject to change and their value depends on the circumstances of the individual investor.
Do I have to accept my pension company's offer?
No, the right to shop around to secure the best rate available has been in UK law since the 1970’s. The Open Market Option as it is known, allows retirees to take their pension fund at retirement an shop around for the best rate.
What else do I need to know?
Some policies come with special rates known as Guaranteed Annuity Rates. These rates might be much better that what is available on the open market and caution should be taken to ask the current provider about special terms before any funds are transferred. This is why it is crucial to take financial advice at retirement.
Glossary of terms - understand the jargon
Annuity Quote - an annuity quote is a quotation you receive from various pension annuity providers taking in to account various lifestyle and health issues you may have.
We quote from the whole of the open market, therefore the annuity quotes you receive from us are from every major provider in the marketplace.
Annuity Tables - independent annuity tables make it easier for consumers to shop around and draw up a shortlist of providers to investigate further.
Taking in to account a consumers' details such as the actual size of their pension pot, their exact age and the type of annuity they would like, annuity tables help explain how the various Annuity Quotes are derived.
Compare Annuities - Once you have entered all of your details in to the quick quote or IFA quote system above, the results returned will allow you to Compare Annuities offered by the various providers. After you have compared annuities we can give additional advice regarding each option to ensure you select the most appropriate product for your circumstances.
Annuity Rates Calculator - an Annuity Rates Calculator is similar to Annuity Tables, after inputting your details the Annuity Rates Calculator will calculate the best annuities for your circumstances and allow you to establish who will offer you the most pension income.
Best Annuity Quote - the best annuity quote is normally the one that offers the most pension income for your circumstances. in order to get the best annuity quote, use our IFA quote system above as this allows you to enter additional details to ensure you get the best annuity quote.
Best Pension Provider - the best pension provider is thought to be the one that offers the most pension income from the open market for an individual's circumstances. The best pension provider isn't always the one that an individual has been saving with all of their life as other pension providers can sometimes offer better rates the the current pension provider.
Annuity Rates 2013 - people are often looking for the best rates for the current year and annuity rates in 2013 are expected to remain subdued.
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