PUT simply, a pension annuity
converts the funds built up in your
pension scheme(s) into a regular
income in retirement. This income
is then payable for the rest of your
life.
If you’re lucky enough to be in a
salary-related (defined benefit) scheme
then the chances are it will provide you
with a guaranteed pension income. If,
however, like the majority of people,
you’re in a
money
purchase
(“defined
contribution”
scheme), then
you will need
to use your
pension
fund(s) to buy a pension annuity to
provide you with your income.
Current UK pension legislation
allows you to start taking your pension
benefits from age 55. You don’t have
to give up work to start receiving your
pension income.
Before buying your pension
annuity, you will normally be entitled
to take up to 25% of your pension
fund(s) as a tax-free cash sum. The
remainder of your fund is then used to
buy your annuity.
Alternatively, you can opt to use
your entire pension fund to buy your
annuity if the provision of income is
your main consideration.
You don’t necessarily have to buy
your pension annuity from your
pension provider. Buying your annuity
from another provider could increase
the income available to you,
particularly where your pension
provider isn’t a specialist annuity
provider or doesn’t offer enhanced
income based on health issues.
A useful starting point is the
government-sponsored “Money
Advice Service” which has annuity
comparison tables for the various
annuity providers, based on the size of
your fund and the annuity payment
options you select. This can be useful
when deciding which providers you
want to request quotes from.
The amount of pension income
you’ll be offered will largely depend on
the following factors:
- the size of your pension fund;
- annuity rates and market conditions
when you buy; - your age and postcode;
n the annuity options you choose; - the state of your health and certain
lifestyle choices.
Your annuity income will be
subject to income tax and will depend
on your individual circumstances.
Certain medical and/or lifestyle
conditions could qualify you for an
enhanced annuity. The more serious
your condition(s), the more income the specialist provider will be able to offer.
There are a number of potentially
qualifying medical conditions and it is always worth discussing your case with
a specialist financial adviser to see if
you could benefit from an enhanced
annuity.
Aside from purchasing a property,
the buying of an annuity is likely to be
the largest financial transaction made
by a vast percentage of the population.
It’s therefore very important that
people make informed decisions when
buying annuities to convert pension
fund savings into an income for life.
Once the 30-day cooling-off notice
has expired, the decision to purchase
the annuity, and terms on which it is
based, will be locked in and can’t be
altered if your circumstances change.
Increasing awareness
Whilst recent research suggests an
increasing awareness of the right to
shop around and that individuals could
be offered extra income based on their
health issues, awareness of how long
they’re likely to live still appears to be
lacking.
Over the last 50 years, the average
life span of women in the UK has
increased by eight years and by 10
years for men. Recent research by the
Institute of Fiscal Studies found that
both men and women tend to
underestimate how long they’re likely
to live and this makes planning for
retirement more difficult.
Analysis shows that men buying a
pension annuity at age 65 are likely to
be paid an income for about 25 years,
whilst women could reasonably expect
an income for longer. Being aware of
this information helps people to be
more prepared for their retirement by
saving more and reviewing when to
give up work.
Providers of annuities have
traditionally used average life
expectancy to help decide how much they can offer people based on their
buying amount and how long their
income is likely to be paid. The yearly
amount offered to customers has
tended to fall over the years as income
payments, given increased life
expectancy, typically have to stretch
over a longer period of time.
Buying a pension annuity is an
important one-off decision and I
would recommend that you seek
specialist financial advice before
making any choices. To reiterate, once
the decision is made then it is usually
irrevocable so it is crucially important
that you are happy with the
implications of your annuity contract,
and have considered all the options,
before signing up to anything.
So are there any alternatives
to an annuity purchase?
There are two main alternatives to
buying an annuity that are now
available: these are capped drawdown
and flexible drawdown. Capped and
flexible drawdowns are both types of
pension drawdown.
The process of pension drawdown
gives retirees a method of drawing
an income from their
pension whilst still
keeping it invested
and under their
control. However,
these options do
carry investment risk
which is not
applicable with an
annuity.
Capped and
flexible drawdown
replaced unsecured
and alternatively
secured pensions as
of April 2011. If you
were already a part of an unsecured or
alternatively secured pension plan then
you will eventually have to use your
remaining fund to either buy an
annuity or transfer to a capped or
flexible drawdown scheme.
Capped drawdown
As an alternative to taking an annuity
you may instead opt into a capped drawdown plan which allows you to
keep your pension fund invested while
taking an income if you need to.
How it works: Instead of purchasing an
annuity with your pension pot, your
pension remains invested in a capped
drawdown plan. You can then draw an
income from your fund.
How much you will receive: The amount
that you take as an income can be
anywhere between 0% and 120% of
the limit set for your age by the
Government Actuary’s Department
(GAD), which is reviewed every three
years. The maximum income outlined
by the GAD tends to be in line with
the average single life annuity rate.
Flexible drawdown
Flexible drawdown is similar to the
capped option, but there is no limit to
the amount of income you may take.
How it works: You must meet the
government Minimum Income
Requirement (MIR) of £20,000pa
before you will qualify. The MIR is the
minimum income you must be
receiving from other registered
pension sources.
How much you will receive:
Unlike the capped
drawdown option, with
the flexible drawdown
plan there is no
maximum amount that
you can withdraw as
long as you meet the
MIR. However, tax
deductions can be high
with this option.
Taking an alternative
option to buying an
annuity can have a
significant impact on
your retirement, and
there may be a certain amount of risk involved in taking a
pension drawdown. Therefore, you
should always consider all available
options before proceeding.
For impartial advice on finding a
retirement income option for your
needs you may want to speak to a
financial adviser who can offer tailored
advice according to your
circumstances.
