Annuities (pension income provision)

When it comes to retirement options there is a multitude of choice and  the Financial Conduct Authority (FCA) states that “It’s a good idea to get professional advice on these and other retirement options”.  ( www.moneymadeclear.fsa.gov.uk ).

This is were radical will ensure you get the best advice to suit your circumstances, even if its just to tell you what you have is already the best.

Below is an idea of some of the options that are available to you coming up to retirements.

Not getting the correct advice at this critical time could cost you thousands in income. Don’t just accept what your provider offers you, talk to us first.

Lifetime annuities

Most people will buy a lifetime annuity with their pension funds. Before you buy a lifetime annuity you’ll have to decide what type you want. Start thinking about your annuity choices at least four months before you retire.

There are different types of lifetime annuities to suit your needs and circumstances. If you have more than one pension plan or scheme, you might get a better income by combining them, although you don’t have to use them all at the same time.

How lifetime annuities work

lifetime annuity pays you an income for the rest of your life. You buy lifetime annuities from life insurance companies or other financial institutions.

When calculating their annuity rates they take account of the fact that some people live longer than others. People who live longer than average will take more from their annuity than, for example, someone who dies three or four years after retirement. So if you die soon after buying your annuity, you won’t have received much from it – people who die early subsidise the annuity rates for those who live longer.

Insurance companies adjust rates because average life expectancy is rising. Interest rates also affect annuity rates because insurers base annuity rates on the return they get from investments. Once you buy an annuity you are locked into the annuity rates offered at that time. You won’t be affected if rates fall, but neither will you benefit if  rates increase.

How lifetime annuities pay out

The amount of income an annuity pays depends on, among other things:

  1. the amount you have in your pension fund;
  2. the amount of tax-free lump sum you take;
  3. whether you have used your fund to contract out of the additional State Pension;
  4. your age;
  5. where you live;
  6. your sex;
  7. your health (in some cases); and
  8. the benefits you choose such as
  • whether the annuity is for you or you  and your partner.

Usually the starting income from the same size of pension fund is higher for a man than for a woman of the same age. This is because, on average, a woman is likely to live longer than a man of the same age.

Government estimates for the UK show that life expectancy for people aged 65 in 2007 will be:
• around 86 for men; and
• around 88 for women.
You could be living on your retirement income for many years.

source: Government Actuary’s Department – cohort figures 2007

 Single-life and joint-life lifetime annuities

Basic lifetime annuities can be single life or joint life. Unless there is a guarantee, a single-life annuity will only pay out during your own lifetime. A joint-life annuity continues to pay an income to your partner after your death. You can usually choose between a  joint-life annuity that pays your partner the same as you were receiving, or two thirds or a half of what you were receiving.

You can also choose a joint life annuity that is level or escalating. If you are not married, check with your provider that your partner will be eligible to receive the income from a joint-life annuity.

With some occupational money purchase pension schemes, you must opt for an annuity that provides a pension for your widow, widower or civil partner equal to half the income you were getting. Your scheme administrator can tell you if this applies to your plan or scheme.

Joint-life annuities are more expensive than single-life annuities because the insurance company will expect to continue paying the annuity for longer.

Level and escalating lifetime annuities

A level lifetime annuity pays the same income year after year for the rest of your life. A level annuity has a higher starting income than escalating annuities but how much you can buy with the income from a level annuity falls as prices rise. To protect your income from rising prices, you can choose an escalating lifetime annuity which pays a lower initial annuity but then increases each year. There are two main choices:

• fixed-rate escalating annuities – your income is guaranteed to increase at a fixed rate each year, say, by 3%;

• RPI-linked annuities – your income is adjusted each year to reflect changes in the Retail Prices Index (RPI), so will rise and fall. With an escalating annuity, the starting income is a lot lower than you would get from a level annuity. It would take around 12 years for the escalating annuity to catch up with the level annuity.

Impaired life and enhanced annuities

Some companies offer annuities that pay you a higher-than-normal income if you have a health problem that threatens to reduce your lifespan. These are called impaired life annuities. Relevant health problems might include, for example, cancer, chronic asthma, diabetes, heart attack, high blood pressure, kidney failure, multiple sclerosis or stroke. You might be able to get an enhanced annuity if you are overweight or smoke regularly. Some companies offer higher rates to people who have followed certain occupations and to people living in certain parts of the country.

Protected rights annuity

If you have contracted out of the additional State pension, known as the State Second Pension (previously called the State Earnings Related Pension Scheme or SERPS), and put your rebates into a personal pension fund, you must use that part of your pension fund to buy a protected rights annuity. Your pension provider will tell you if protected rights applies to you and what it means in your circumstances.

With a protected rights pension you:

• can take your protected rights pension at the same time as your occupational or personal pension, provided you are over 55 years old and your pension scheme rules currently allow you to take your pension at age 55. This lower age limit will be going went up to 55 from 50 1n 2010;

• can convert up to one quarter of your protected rights fund into a tax-free lump sum;

• will have to buy a joint-life annuity paying a 50% spouse’s pension if you are married or have a civil partner; and

• can choose between taking a level or escalating annuity.

Guaranteeing your lifetime annuity

payments If you die soon after buying an annuity, it will not have paid out much. You can choose from two options to ensure that if you die soon after buying an annuity your annuity doesn’t die with you.

Guarantee periods

Guarantee periods are usually for five or ten years’ worth of income, even if you die within this period. On your death, the income may continue to be paid for the rest of the guarantee period. If anyone is financially dependent on you, do not look on a guarantee period as a substitute for a joint-life annuity. If you choose a joint-life annuity, a guarantee period may not be useful as you will have already arranged for a proportion of your annuity to continue to be paid on your death.

Annuity protection lump-sum death benefit

You can ensure that if you die before the age of 75 your money doesn’t die with you by taking out an annuity protection lump-sum death benefit. A lump sum equivalent to the pension fund you used to buy an annuity, minus income you’ve received, will be paid to your estate or beneficiaries. There will be a tax charge and may also be an inheritance tax charge on this payment. If you want this option you will need to ask the annuity provider for it. Bear in mind that if you take this option it will reduce the amount of money you get from your annuity because you will be paying for the protection.

Investment-linked annuities

Investment-linked annuities put your pension fund into investments, such as stocks and shares. This means that you could continue to benefit from stockmarket investments after retirement, but there is also the risk that the value of your investments could fall. investment-linked annuities can be either:

• with profits; or

• unit-linked.

With an investment-linked annuity you will be linking your income in retirement to the ups and downs of the stockmarket instead of receiving a pre-set income, as you would with a lifetime annuity.

With-profits annuities

Your pension fund is invested in an insurance company’s with-profits fund. Your income is linked directly to the performance of this fund. Your income is usually made up of two parts:

• a starting income

This is set at a low level, but, unless investment conditions are very bad, you’ll usually get at least this much income. Some providers may guarantee a minimum level of income.

• bonuses

The insurance company usually announces bonus rates once a year. Bonuses can be both reversionary (usually paid each year for the duration of your annuity) and special (paid for a year or so) until the next bonus announcement. The amount of any bonuses depends on many factors, such as:

• how well investments are doing – for example stockmarket performance;

• business risk – the financial strength of the fund; and

• the insurance company’s assessment of what it can afford to pay out in bonuses. Bonuses are not guaranteed. Whether or not you get a bonus depends on the financial strength of the firm.

Unit-linked annuities

Your pension fund is invested in units in investment funds. Your income is linked directly to the funds you have invested in. You can usually choose the types of fund, for example:

• medium-risk managed fund

A fund manager selects a broad range of different shares and other investments. Spreading your money in this way may reduce risk, although investment risk cannot entirely be removed.

• higher-risk managed fund

A fund manager selects shares and other investments in a particular country or sector, such as smaller companies. Because your money is less widely spread the risk is higher.

• tracker fund which closely follows the performance of a particular stockmarket index and reflects the level of risk within that index. Usually, tracker funds have lower charges than managed funds. The more risky the underlying fund you choose, the more your retirement income may vary – both up and down.

Retiring gradually or retiring later

Using annuities to retire gradually, Instead of using the whole of your pension fund(s) to buy an annuity you can retire gradually.

Phased retirement uses part of your fund to buy an annuity. The rest of your fund remains invested. You can later use another portion of your fund to buy another annuity. In this way you can provide a flexible income. Each time you convert part of your fund to an annuity, you can first take some taxfree cash from this portion of the fund.

Converting portions of your fund regularly – for example, once a year– means you can effectively use the tax-free cash, as well as the annuity, to provide your income. Insurance companies often set a minimum fund size for annuity purchases so you must convert enough of your fund each time to enable you to buy an annuity.

Phased retirement can be a useful financial planning tool, for example if you want to ease back gradually on work and start to replace your earnings with pension income. It also provides more flexible help for your survivors if you die. The part of the fund you haven’t converted to annuities can pay a pension or a lump sum for your surviving dependants, depending on the terms of the pension plan.

Postponing your annuity and retiring later

You don’t have to buy an annuity with your pension fund at retirement. You may consider postponing buying an annuity until a later date. Alternatively you may decide not to buy an annuity at all and draw an income directly from your pension fund instead.

If you delay buying an annuity you might expect a higher annuity rate because you’re older. But because people are on average living longer, annuity rates are adjusted from time to time to reflect this. So it could be risky to assume that annuity rates will be much higher if you postpone buying your annuity. And of course rates may fall or rise for various reasons.

You can also postpone taking your State Pension, in exchange for getting a higher pension or a taxable lump sum when you do decide to take it. See Useful contacts for details of how to get a leaflet about this from the Pension Service.

Other retirement options

If, for whatever reason, you decide that you’re not ready to buy a lifetime annuity, you will have the following options:

• an unsecured pension using short term annuities;

• an unsecured pension using income withdrawal.

However, you must secure your pension income by your 75th birthday at the latest, as an annuity – or as an alternatively secured pension.

Unsecured pension

An unsecured pension means that after taking any tax-free cash, the rest of your pension fund remains invested.

Unsecured pension using short-term annuities

With a short-term annuity, you can use part of your pension fund to buy a fixed-term annuity lasting up to five years. You can choose your annuity options in much the same way as basic annuities. In the meantime, the remainder of your fund continues to be invested.

At the end of the term of the annuity you can buy another short-term annuity. You can also combine income from a short-term annuity with income withdrawal. You can continue in this way until you are ready to buy a lifetime annuity or before you reach age 75.

Unsecured pension using income withdrawal

With income withdrawal you can take a taxable income direct from your pension fund. This is also known as income drawdown or pension fund withdrawal. Income withdrawal is an option with most personal pensions and some occupational money purchase schemes. In some cases if you are in an employer’s scheme and want to use income withdrawal, you must first transfer your pension rights from the employer’s scheme to a personal pension.

HM Revenue & Customs (HMRC) sets a limit on the maximum amount of income you take from the fund. You must review your arrangement every five years to make sure it is within this limit. There is no minimum amount of income that must be taken.

Phased retirement and income withdrawal can be combined

This means you would start to draw an income from just part of your pension fund on one date, leaving the rest of the fund intact.

To increase your income at a later date, you could either increase the rate of withdrawal (provided you did not exceed the maximum limit) or start to draw an income from a further slice of your pension fund.

If you use one of the above unsecured pension options you must then decide how to secure an income from your pension funds before you reach age 75. This generally means buying a lifetime annuity.

Alternatively secured pension

On your 75th birthday, if you haven’t bought an annuity, another option is to use an alternatively secured pension. This works in a similar way to unsecured pensions but has different limits and rules.

Alternatively secured pensions are not suitable for everybody and it is important that you take professional advice if you are thinking of taking this option. Inheritance tax and other significant tax charges may apply to any leftover funds on your death.

Hybrid products

Hybrid products pay a regular income and offer guarantees of either investment growth or the amount of pension fund you can expect to have left to buy an annuity later on.

They vary in what they’re called, the guarantees they offer and the charges  they make to cover the cost of the guarantees. You generally have to give up some investment growth potential to pay for the guarantees.

Please note, that annuity rates based upon gender will be abolished from 21st December 2012.

The value of investments and income from them may go down. You may not get back the original amount invested.

Tax treatment is based on individual circumstances and may be subject to change in the future.

source; Our  money made clear  guides – “your retirement options”  December 2008, produced by the FSA

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