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.
5. 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 40-year guarantee period, this has the effect of reducing the income, compared to the five year guarantee.
6. '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.
7. 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
8. 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, since April 2015 retirees have been able to withdraw their pension funds as income without restriction, effectively meaning that if required a retiree can take the whole fund as income in one go.
While this may sound attractive to many, the reality is that few will do so because of the tax implications. While 25% of the fund can be taken as a tax-free lump sum, in most cases the remainder of the funds are taxed as earned at your marginal tax-rate. This means in effect that the pension you take out is added to your income for that year.
What are the alternatives?
Unsecured Pension (USP)
(also known as Pension Fund Withdrawal or Flexible Access Drawdown)
Since April 2015 there have been NO restrictions on the income allowance from a pension, meaning a retiree can take any income between zero and the full fund value subject to taxation. Previously an upper limit was in place which was based on your age and rates set by the Government Actuarial Department, known as GAD rates.
Since April 2015 everyone has been eligible for Flexible Access Drawdown, which allows you to take out an income that isn’t restricted by GAD Rates.
Alternatively Secured Pension (ASP)
On reaching age 75, any remaining pension fund can be used to purchase a lifetime annuity or an Alternatively Secured Pension (ASP). ASP operates in a similar way as USP, but with some different rules:
The maximum income you can withdraw is about 90% of a level single-life lifetime annuity and the minimum is 55%. These limits must be reviewed every year. Regardless of your actual age, the maximum income will be based on age 75.
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 a spouse, civil partner or dependant's ASP for someone over age 75, or
Provide 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 a charity lump sum death benefit, or
Provide 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?
Definitely not. Your pension companies will want you to choose their annuity offerings, but the rules state that you don't have to. Everyone has the right to use the 'open market option', by shopping around and choosing the annuity that suits their needs best. A starting point could be to consult My Pension Expert. There can often be a substantial difference between the highest and lowest annuity rates available, often amounting to thousands of pounds over the average investor's retirement.
What else do I need to know?
Some older style pension policies have valuable guarantees that mean they will pay a much higher rate than the current market allows, this is due to the inclusion at inception of Guaranteed annuity rates (GARs). This sometimes valuable inclusion could result in an income twice or even three times as high as policies without a GAR.
Glossary of terms - understand the jargon
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 2012 - people are often looking for the best rates for the current year and Annuity Rates in 2012 are expected to remain subdued, female Annuity Rates are expected to increase in December 2012 in line with European Legislation.
Pension Annuity Providers - there are other terms used relating to pensions such as Pension Annuity and Pension Annuity Providers. Pension Annuity Providers are simply the companies that offer to pay an individual an income in return for the pension pot they have accumulated. There are many Pension Annuity Providers and it is important to get quotes from all to ensure the most possible pension income is achieved.
Buying an Annuity - when an individual comes to retire, the money they have saved in their pension pot goes towards Buying an Annuity. The Annuity pays the individual an income which is derived from the amount of pension pot they have. The key is to seek advice when Buying an Annuity to ensure you get the most possible pension income.
Pension Advice - the most important thing people can do when it comes to retiring is seek Pension Advice. At My Pension Expert we specialise in retirement planning, therefore the Pension Advice we give is always geared towards maximising an individuals pension income. We are a company of Independent Financial Advisers so any Pension Advice given is regulated by the FSA.
Is the upper limit of pension contribution allowed under HMRC rules into a pension scheme. The rate currently stands at Â£40,000 per year but this this can fall to Â£10,000 if you withdraw an income that exceeds the GAD limit.
Is the individual receiving the annuity income.
Is an investment held with an insurance company, purchased with the proceeds of a pension fund to secure an income for the remainder of the annuitants life.
Anticipated bonus rate (ABR)
ABR is the benchmark growth rate that a With Profits or Invested annuity must achieve to maintain the selected income level. The ABR is usually between the range of 0 and 5%. With Profit fund performance over that of the ABR will increase the annuity income while fund performance below the ABR will reduce pension income.
Attitude to Investment Risk (ATR) ATR is the capacity of an individual investor to accept capital risk to their investments. Someone with a low ATR would suffer emotional strain and hardship if the value of their investment of income was to reduce due to poor performance. Those with a high ATR are more willing to put capital at risk in the hope of achieving better investment returns. ATR is importance when considering pension options.
The rates offered by annuity providers on the open market to attract investment.
Funds built up from "Opting out" from SERPS (State Earnings Related Pension). These funds no longer carry the same restrictions since legislation changed in April 2012 but some funds might carry some restrictions over the ability to transfer to another provider.
Cost of Delay
The financial loss associated with the delayed purchase of an annuity whereby income is lost in the time taken to make the purchase.
Compulsory Purchase Annuity
Is the name given to an annuity purchased with the funds from a money purchase pension scheme whereby the purchaser is obliged to buy an annuity with the proceeds.
Consumer Price Index is a measure by which an annuity income can increase.
Income paid after the death of the annuitant. If selected the dependents pension can be paid to a spouse, civil partner or financial dependent of the annuitant.
Is an annuity where additional income is paid due to the annuitants poor health. The annuity company takes the view that the health and lifestyle problems could shorten the life expectancy of the annuitant.
Is where the annuitant has selected to have their pension annuity income increased each year. The rate of escalation can be from zero up to 5% or CPI or RPI.
Final salary pension
Often referred to as Defined Benefit pension, is typically linked to a pension provided through the work place. The amount of pension income is based on final or average earnings of the member rather than the size of funds at retirement. The benefits are usually higher for a Final Salary pension and for this reason they are becoming more rare.
Is an individual or a company who is authorised by the Financial Conduct Authority to give advice on a range of financial products and services. Independent Financial Advisors (IFA) can provided quotes and give advice on the whole of the market place.
Is someone who is fully or partially dependent on the financial income of another. Where a dependent's income is chosen and the dependent is not married or in a civil partnership the annuity company may need proof of financial dependency, typically a joint bank account or shared mortgage.
Financial Conduct Authority (FCA)
The Financial Conduct Authority is responsible for regulating the Financial Services industry.
Financial Services Compensation Scheme
A financial compensation scheme in the event of the failure of authorised firms. Covers insurance companies, deposit-takers and investment firms. Annuities are covered to 90% of the value of the investment without any upper limit.
Guaranteed Annuity Rates
Some pension contracts promised to pay the policyholder a guaranteed annuity rate at a set age. Because these rates were secured at a time when annuity rates were generally much higher they remain very attractive when compared to what is available on the open market today.
Guaranteed Minimum Pension
Some pension contracts include GMP which is a minimum pension income at a set age irrespective of the size of the funds at retirement.
The period of time that the pension income from an annuity will be paid from inception irrespective if the annuitant is alive. Zero to 40 year periods can be selected.
Are a loan to the British Government whereby they promise to pay a set rate of interest over a set term. As they are extremely safe they are used by annuity companies to provide dependable income which in turn is paid out as pension income to investors.
Is the average rise (or fall) of a set number of goods and services within the UK economy. When the average price of the measured goods and services is higher than the previous period, this will give rise to inflation. (RPI) is the primary measure of inflation in the UK.
An annuity where past or present health problems can potentially give a higher annuity income. The annuity company take the view that certain health problems will lead to a shorter life expectancy so will pay a higher income.
Lifetime allowance (LTA)
The LTA is currently set at Â£1.25 million, however there are proposals in the works to lower it to Â£1 million in April 2016.
Market Value Reduction
Market Value Reduction (MVR) is a penalty that pension companies apply to funds that are transferred out at a time of volatile market conditions where their policy terms allow this.
Money Advice Service
A free service established by the FCA to help people understand complex financial products and services.
Money purchase scheme
Can be private or through employment. The funds are built up during the member's working life and used to secure a pension income at retirement. The level of income depends wholly on the value of the funds accumulated. Also referred to as defined contribution schemes.
Open market option (OMO)
The right set by legislation to â€˜Shop around' for the best annuity rates at retirement with accumulated pension funds.
The payment of income from the date of death to the next income payment where the annuity income is paid in arrears. If the plan has proportion the time between death and the next due payment is paid to the estate of the deceased. Particularly important when income payment periods are longer i.e. annually.
Pension Commencement Lump Sum
see Tax Free Cash Sum
Registered pension scheme
Is a scheme that has been registered with HM Revenue & Customs under part 4 of the Finance Act 2004. Pension funds built up within registered pension schemes are tax privileged and contributions to them will usually benefit from tax relief.
Retail Prices Index (RPI)
Tax-free cash sum
Also referred to as the Pension Commencement Lump Sum this is the ability to take up to 25% of the pension fund at retirement as a tax free cash sum. Some restrictions can apply to certain schemes. Care should be taken when deciding to take the PCLS as the option will not be available again with certain retirement options.
Is a type of death benefit that can be selected with different types of retirement plans. Value protection can be between 0% and 100% and will pay out the value of the invested funds less income taken to the date of death.
With Profits annuity
A type of invested pension annuity where the income paid is a variable amount depending on ongoing fund performance. The income is paid for life and will come with a minimum income guarantee.
With Profits bonuses
Are the returns paid by the insurance company to the With Profits annuity plan based on the performance of the funds
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