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retirement options |
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Buying an Annuity
Buying an annuity means using your built-up pension fund to buy the guarantee of an income for life (known as a pension) from an insurance company. The annuity will either remain level or increase annually and may be guaranteed to be payable for a minimum of 5 or 10 years.
Before you buy your annuity you can also take the option to receive a tax-free cash lump sum from your pension fund with the remainder being used to purchase an annuity.
The value of the annuity will depend on several factors including:
- Your age
- Current interest rates
- The value of your pension fund
- The type of annuity you choose
- The insurance company from whom you purchase your annuity
- The guarantee period chosen
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Annuity rates are based on long term gilt rates and therefore influenced by interest rates. With interest rates at their current level, annuity rates are currently at their lowest ever level.
Annuity rates generally will only increase if it is anticipated that long-term interest rates will also increase.
Conventional Annuities
At retirement your pension fund (normally after payment of any tax-free cash sum entitlement) is used to purchase an annuity, which provides you with a pension. These pension payments will continue throughout your lifetime.
There are different types of annuity designed to suit your personal circumstances. For example, a reduced annuity in return for an annuity payable to your spouse in the event of your death. Other options include a level or increasing annuity, or an annuity that is guaranteed to be paid for a period of years irrespective of when you die.
The type of annuity you choose is fixed at retirement and cannot be changed after payments start unless an escalation rate is included.
To give you an idea of how the type of annuity you choose will affect your retirement income, below is an example of different annuity options open to a male age 60, with a wife age 57 and a pension fund of £200,000, for a pension paid monthly in advance:
The cost of annuity options
Source: The Insurance Trading Exchange and Financial Express March
2003
With Profits and Unit Linked Annuities
As an alternative to buying a conventional annuity, there is the option of buying a with profits or unit linked annuity. These work on the same basic principles as conventional annuities, the only real difference is the way the underlying funds in are invested.
With profit and unit linked annuities are invested in equities, which makes them riskier than conventional annuities, which invest in gilts. However, they do offer the chance to boost your income.
With profits annuities are linked to the provider's with profits fund, and income will vary according to future bonus rates.
Investment linked annuities are linked directly to unit linked funds, and income levels will depend on the performance of the underlying funds.
Generally, the charges associated with with profit and unit linked annuities are higher when compared to conventional annuities as they are more complex contracts.
Further details are available on request.
Term certain annuities
Where an individual is taking Unsecured Pension it will be possible to purchase a term certain annuity for up to 5 years. The income from the term certain annuity counts towards the maximum income withdrawal allowable under Unsecured Pension up to the age of 75. All term certain annuities must end by age 75.
Impaired Life Annuities
Occasionally it is possible to improve the annuity rate offered if you suffer from a serious medical condition or you smoke. It is therefore important that you make us aware of any health problems you may have so that this option can be fully considered.
Market Segmentation Annuity
A new development in the annuity market is the introduction of annuity
rates that are based on occupation and postcode. In general terms,
the more hazardous your occupation whilst working, the greater pension
you may receive in retirement.
This is a relatively new development with very few insurers offering these enhanced rates. However, it is a market that is expected to develop.
What happens on death
When you die, your estate may receive a lump sum representing the remainder of any guaranteed instalments. However, this depends on the options you chose when you bought your annuity. These options are fixed from outset and cannot be changed to adapt to changes in your personal circumstances such as marriage.
Advantages
- Buying an annuity is straightforward, with minimum paperwork and no on-going reviews.
- Once established, there is nothing further for you to do and no further charges.
- You receive a guaranteed income for life, which cannot fall (except for with profit and unit linked annuities).
- You have no or limited exposure to investment risk.
- You can receive all your tax-free cash lump sum at the start.
Disadvantages
- The death benefit could be low if you die soon after you purchase an annuity.
- The annuity could provide poor value for money if rates are low when you retire.
- Your circumstances may change after retirement. Annuities are not flexible; once you have purchased it you cannot alter it in any way e.g. adding a spouse's pension.
- Your annuity cannot be altered in value (except for standard increases) to take account of fluctuations in supplementary sources of income
Protected Rights
Protected Rights accrues as a result of you contracting out of the Second State Pension (S2P) previously known as the State Earnings Related Pension Scheme (SERPS).
Following the introduction of new pension legislation in April 2006, it is now possible to take 25% of the Protected Rights pension fund as a tax-free lump sum.
All annuities purchased from a Protected Rights fund are based on unisex annuity rates and must include a 50% spouses pension if you are married at the date of retirement.
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