Annuities
June 2010
Drawing an income in retirement. It’s payback time.
You’ve scrimped and saved all these years, and now it’s time to retire. What do you do to get your hands on your hard earned savings? One answer could be an annuity.
What is an annuity?
An annuity is an investment product that is bought using your pension fund or other savings which guarantees you a regular income for life or for a fixed period of time.
So how much will you get? Basically, your income will depend on three key factors: the size of your fund, interest rates and your life expectancy.
Buying an annuity depends very much on your state of health, and it’s worth shopping around as rates can vary quite dramatically between annuity providers.
You do not have to buy your annuity from your current pension company either. You could take what’s known as the ‘open market option’ and see what’s on offer from other pension providers.
What are the rules?
Unless you are part of a final salary pension scheme, you will use at least some of your pension fund to provide an income by age 75. (Exceptions are made for some groups who object to buying annuities for religious reasons.) Pension income after 75 can also be delivered via an Alternative Secured Pension (ASP), however these arrangements are not suitable for everyone, and for many people an annuity is likely to be the preferred option.
Types of annuity
There is a wide choice of annuity options:
Basic annuity - provides a steady income for life which never changes and payments stay the same
Phased annuity - payments can be deferred for those who do not need an income immediately
Index-linked annuity - ensures your income keeps pace with inflation
Joint life annuity - pays an on-going income to your partner after you die
With-profits annuity - provides a level of income, and the potential to have an income that grows subject to bonuses
Impaired Life or Ill-health annuity - although annuity rates have suffered in recent years, this type of annuity can make sense if you are in poor health when you retire. If your life expectancy is likely to be shorter, your annuity payments will be correspondingly higher.
And remember, annuities can offer financial security. With an annuity your income is guaranteed not to run out, but there is a risk that in choosing a level income, inflation will reduce it’s buying power.
There are some newer, more innovative types of annuities that have been introduced in recent years.
Variable annuities are investment-linked retirement products, with the potential for income to increase. This reduces the effects of inflation, plus there is the opportunity of capital growth for the money that is left invested.
Fixed-term annuities are a type of annuity written under Unsecured Pension (USP) rules. This means it can provide some of the benefits of both conventional annuities and income drawdown. Fixed-term annuities provide a fixed income (subject to certain limits) for a minimum of five years, and up to a maximum age of 75.
These types of annuities provide less protection than the guarantees of conventional annuities. Guarantees cost money, so there is a risk attached to investing in these compared to conventional annuities.
Keep your options open
You can see that you do not have to buy your annuity immediately on retirement. If you do not want to buy an annuity straight away, you may want to consider drawing an income directly from your pension fund – this is called income withdrawal or income drawdown. Generally, income drawdown is only viable for those whose pension funds on retirement are in excess of £100,000.
On the plus side, your money stays invested so that your pension pot has the potential for growth, however that does entail some risk.
You therefore need to keep a watchful eye on how your investments are performing and how much you are withdrawing from your overall fund so that the money doesn’t run out - remembering that eventually you will have to take a pension income from the fund.
Keeping your options open also means that as your needs (and those of your dependants) change, you may need more income. For example, at 60 or 65 you may still be working or have financially dependent children. In later life, you may be able to get a higher income when you buy your annuity.
How to find out more
We don't konw what the future holds, but retirements are getting longer and we need to make annuity choices that will give us the best income options. Annuities are a complex subject, and you really need to talk to a financial adviser.
You and your money provides general information and not advice. If you are seeking advice on financial matters you should contact a qualified financial adviser. If you do not have a financial adviser, you can search for one here.
