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Annuities Explained

What exactly is an annuity? Which one should I choose? How do I get the maximum income from my annuity purchase?

All these questions are addressed below and the information provided could make a sizeable difference to your eventual income in retirement.

If you are saving money in to a personal, stakeholder or money-purchase pension plan you will most likely choose to buy an annuity when you choose to retire. The UK’s previous laws required that your pension savings were converted into an annuity or drawdown scheme by the age of 75. This changed in April 2011 and you are now free to delay the decision indefinitely.

It is important at this stage to understand that you are under no obligation to purchase an annuity from your current pension provider. Despite this, an alarming two-thirds of retirees do opt to buy an annuity from their current provider, according to Reuters. Many of these retirees will be receiving incomes significantly lower than they would have had should they have chosen to shop around the entire market.

There are sizeable differences in the performance of the best and worst pension annuity plans, so it is important to seek the advice of an independent financial adviser before choosing your options.

You can find a local, qualified advisor through the Financial Advisor Network, a nationwide network of independent IFA firms here.

What actually is an annuity?

A pension annuity is a form of insurance policy that provides a recurring income in exchange for a lump sum (pension pot).

When you reach retirement you have to convert the capital built up in your personal pension policy and through any additional voluntary contributions (AVCs) into a regular pension. You can take up to 25% of your pension pot as a tax-free lump sum, but the rest must eventually be converted into an annuity.

Annuities, in some respects, are like life insurance policies in reverse. The policy provider makes an estimation as to how long you will likely live, based on your health and demographic averages, and then uses this to calculate a yearly income that they will pay you.

Annuity rates have been falling for two decades, predominantly due to extending life expectancies meaning payments must be spread out over more years.

A 65-year-old male may expect a typical annual return of just 6-8% from his pension pot. As such, a pension pot of £100,000 would provide him an income of £6,000 to £8,000 per year. Falling and suppressed annuity rates mean it is even more important than ever to see the advice of an IFA who can examine the various options available to you, many of which are very complex.

The annuity rates offered by the various providers vary significantly. As such, shopping around on the open market is the best way to find the most suitable and highest paying annuity plan for you.

Switching providers could increase your retirement income by hundreds, perhaps even thousands, per year for your entire retirement. It may also open up other types of annuity options available to you that may better suit your personal needs, attitude towards risk/reward and other factors.

Types of annuities

The majority of retirees opt for a conventional lifetime annuity plan, however, there are many options to choose from. Some have been increasingly attractive in light of poor government gilt returns but deciding which one is right for you should be done in consultation with an IFA.

  • Level/standard annuities provide a fixed income each year.
  • Increasing annuities provide an income that is consistent in line with inflation.
  • Guaranteed annuities will continue to pay out to a nominated individual should you pass away.
  • Investment-linked annuities are tied to the performance of the assets that they are invested in, typically stocks and shares.
  • Joint-life annuities gives your partner all or a portion of your income should you pass away before them.

Shockingly, figures from the Association of British Insurers (ABI) show that nearly two-thirds of retirees in 2011 bought their annuity from their pension provider. The overwhelming majority of these would have missed out on potential income by failing to explore the options available on the open market.

Get started: Compare annuity rates now using our annuity calculator (January 2013 updated).

Geoff Alderton – Last Updated: 18th Mar, 2013

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