It used to be that all pensions involved annuities.
You would save into your pension fund, and when the time came to retire, you used all the money you had built up to buy an annuity. It would provide a guaranteed income for the rest of your life, and If you lived a long while in retirement it might mean getting back much more than you paid in.
Once in place, annuities are worry-free. You don’t need to think about how much to withdraw or be concerned about what the stock markets are doing. Your income will be secure and paid to you no matter what happens. You can even arrange for a proportion of your pension to be paid to your spouse after your death.
But there are two big problems with annuities.
One is that with a basic annuity, your income is fixed. If you live for 30 years in retirement, the purchasing power of your income will shrink by 30 years of inflation – which is particularly worrying now with inflation heading towards 10% a year. If inflation continues at this rate, your annuity would halve in purchasing power in approximately 10 years.
The other is that annuity rates – how much income you can buy with your pension pot – are low. Many people find that an annuity simply does not offer good value, and that their big pension pot equates to a disturbingly small income.
But although drawdown may offer the prospect of flexibility of how to take their benefits, your capital is at risk meaning investment values are not guaranteed and the value of your investment could go down and impact on the level of retirement income. For many people, there could be circumstances when an annuity could still be worth considering.
How exactly do annuities work?
You can buy an annuity at any time, once you turn 55 (rising to 57 from 2028). You can usually choose to have up to 25% of your pension pot paid to you as a tax-free cash lump sum and use the rest to buy the annuity. The annuity income you receive is taxed as earned income. You may also need to consider if drawing an annuity would affect your entitlement to any means tested state benefits.
Once you’ve bought your annuity and secured the annuity rate, your income is set for the rest of your life and cannot be changed.
You’ll need to answer a few questions about yourself when you get a quote. Make sure you confirm your health and lifestyle details – it could mean you’ll qualify for more income.
Factors that affect your annuity income
The size of your pension pot. The bigger your pension pot, the higher your potential income could be.
Annuity rates. Annuity rates determine how much income you could get. They change all the time because they’re linked to the yield made on government bonds (gilts) and are sensitive to interest rate changes. High interest rates and high yields mean higher annuity rates.
The type of annuity you choose. You can choose for your annuity to be fixed, to increase over time to compensate for inflation and if your income should continue to your spouse when you die.
What about enhanced annuities?
Enhanced annuities pay you a higher income because of your health and lifestyle choices.
If the insurance company believes you will not be claiming your annuity long, they may pay a better rate. So you’ll tend to get a higher annuity income the older you are and if you have an unhealthy lifestyle.
So the older you are when you take out an annuity, the more suitable it could be.
Common conditions such as diabetes, high blood pressure or high cholesterol can increase your income. Smoking and past smoking usually qualify too, to make sure you get the highest income possible. It’s important to confirm as much information as you can, including your partner’s details, You can usually find out if you qualify in minutes.
So could an annuity be right for you?
There are circumstances when an annuity could be a wise choice. Remember, these days you don’t have to buy one as soon as you retire.
Annuity rates tend to be higher the older you get and the more health conditions you have, so you could qualify for more income if you wait. It could provide problem-free income for your later retirement.
Perhaps the best solution is to get independent advice about planning your retirement and ensuring that your pension pot is always used in the most effective way with regular reviews.
At Continuum we can help. With regular reviews, we can ensure that you always have the pension arrangements you need, and that you will know when and if it is time to consider an annuity.
To discuss annuities, or any other aspect of retirement planning, contact us today.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable retirement strategy, you should seek independent financial advice before embarking on any course of action.