What is a Pension Annuity?
Annuities are an important way of turning personal pension savings into pension
income. A standard pension annuity is an arrangement where a lump-sum investment is made. From the investment you will receive a guaranteed level of retirement income. There are also alternative types of annuities that provide greater flexibility. Most annuities are bought using funds held in money purchase pension schemes.
In other words, an annuity converts a savings fund into income and that income will be paid to you for long as you live. The annuity is payable for the remainder of you life after it's been purchased, although it's possible to select a fixed period if purchasing an annuity with cash rather than pension funds.
Examples of these types of "Compulsory Purchase Annuity" are conventional annuities, with profit annuities and unit linked, or 3rd way annuities. Annuities that are bought from savings, not from a pension scheme are referred to as Purchase Life Annuities or Immediate Vesting Annuities.
The UK Government believes that pension annuities continue to provide a financially efficient and secure means of turning pension capital saved through defined contribution pension arrangements into income that lasts for all of retirement. Annuities ensure that people continue to receive a pension income from their savings no matter how long they survive. Annuities reduces possible future need for income-related support from the Government.
Annuities provide a financially efficient, secure means of turning your pension capital into pension income. Because annuities pool risk, they ensure that people get better returns without fear of running out of money. Annuity contracts between the provider and the retiree should deliver a sufficient and secure income for the duration of the life of the retired person who buys it in return for surrender of their pension capital.
Tax Free Annuity Cash
You're normally entitled to take up to twenty five percent of your pension fund as tax free cash. The remainder of the fund must be used to purchase an annuity or alternatively secured pension (Compulsory Purchase Annuity), before you reach 75 years of age. The conversion of pension income into an annuity is mandatory by the age of 75. Your annuity will be treated as pension income under UK Pay-as-You-Earn tax rules.
An Annuity is for Life
This could be one of the biggest financial decisions that you will ever make, so you must ensure that you maximise your annuity income. Once you buy an annuity you can't change your mind afterwards. You need to ensure you get it right first time.
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Types of Annuity:
There are a wide range of options which can be selected when choosing an annuity plan. The most widely used annuity options are listed below.
Minimum Term Annuity
Income is guaranteed to be paid until the death of the annuity holder (annuitant), but it can also be modified to include any of the following options:
• 5-year annuity guarantee - annuity ceases at death of annuity holder, or after 5 years, whichever is the longest
• 10-year annuity guarantee - annuity ceases at death of annuity holder, or after 10 years, whichever is the longest
• Joint life annuity - annuity ceases on the death of the second of two named annuity holders
Annuity Spousal Benefits
Your spouse, partner or dependant can be protected after your death if you choose one of the following options:
• Reduction to half benefit,
• reduction to two thirds benefit or
• full benefit
The annuity is thus adjusted to the new level at the death of the annuity holder or at the end of the guarantee period (if this has been selected) and then continues until the death of the spouse, partner or dependant.
Annuity Escalation
An annuity can either be paid at a fixed level or can include an escalation at 3 percent, 5 percent, or at the RPI percentage (annual increase in the Retail Price Index) - you can choose to compensate for any inflationary effects on your retirement income. However, your initial income level will be reduced if you choose escalation. Your specialist annuity adviser can look at a range of annuity options with you to help you decide on the best option for your particular circumstances.
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Pension Types?
You can buy an annuity if you have one of the following pension types:
1. Personal Pension
2. Stakeholder Pension
3. Occupational Money Purchase Scheme
4. Retirement Annuity Contract (RAC)
5. Free Standing Additional Voluntary Contribution Scheme (FSAVC)
6. Most Additional Voluntary Contribution Scheme (AVC)
7. Section 32 Policy (Buy Out Bond)
Converting Pensions From?
Abbey Life
Aegon
Allied Dunbar
AXA Sun Life
Barclays
Canada Life
Clerical Medical
Countrywide Assured
Eagle Star
Equitable Life
Friends Provident
Halifax
Legal and General
National Westminster
Prudential
Scottish Equitable
Scottish Life
Scottish Mutual
Scottish Widows
Skandia
Standard Life
Windsor Life
Winterthur
Zurich
and many other Pension Providers
Your Pension Annuity From?
Aviva Annuities
Canada Life Annuities
Clerical Medical Annuities
Friends Provident Annuities
Just Retirement Annuities
Hodge Lifetime Annuities
Legal & General Annuities
Liverpool Victoria Annuities
MGM Annuities
Partnership Annuities
Prudential Annuities
Reliance Mutual Annuities
Scottish Equitable Annuities
Scottish Life Annuities
Scottish Widows Annuities
Standard Life Annuities
and many other Annuity Providers
Purchased Life Annuity: An Annuity With a Difference
A purchased life annuity is an annuity purchased with your own funds (savings), as opposed to from a money-purchase pension fund. This type of annuity operates in the same way as a compulsory purchase annuity, but has tax advantages.
The entire pension that you receive from a compulsory purchase annuity is treated as taxable income in the same way as income from normal employment. But when you buy a purchased life annuity, that part of the annuity income, which is calculated as capital repayment to you, is free of tax. Only the portion of your annuity income that is interest-paid on your investment is taxable.
With similar annuity rates, the effect of this tax treatment of a purchased life annuity, for a basic-rate tax payer from a £200,000 investment would be to increase their net retirement income by somewhere in the region of £200 per month.
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The Open Market Option for Buying Annuities
The Open Market Option allows retirees to shop around for varying ways to convert their pension funds into an annuity or annuity alternative, as opposed to just settling for the rate offered by their pension provider.
Pension Providers Annuities Information
When your pension fund reaches its maturity, your pension provider will write to you to advise you of the fund value and give you general information about annuities and the level of annuity income you would expect from them.
You are now entitled to use your Open Market Option, which allows you to transfer the pension fund value to the annuity provider of your choice. This enables you to take advantage of a possible higher annuity income which may be available from a different provider. Annuities are usually provided by insurance companies.
What The FSA Say About Shopping For Annuities
You could receive much more retirement income from a pension annuity than you think. The Financial Services Authority (FSA) agree; they say "You may be able to get a better annuity rate by shopping around. You should check what your provider is offering you and then compare this with the annuities on offer through the open market."
Unfortunately, many of those who retire still do not use their Open Market Option. This is not just because they are not aware of the benefits of doing so, but they do not actually realise that they have an option at all. It has been claimed that those at retirement who do not use their option and take the default annuity offered by their pension provider, may be missing out on up to as much as 40 percent more retirement income.
Will You Receive the Correct Annuity Income?
According to the professional pensions publication, DC World, it is estimated that over £1 billion in pensions was lost by failure to get proper advice on the best-selling annuity.
To make the most of the Open Market Option, it's important that you speak to an Independent Financial Adviser (IFA) who'll explain the different annuity options and alternatives to annuities that are available.
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Enhanced Annuities / Impaired Annuities
First introduced to the UK in 1995, enhanced annuities or impaired life annuities have a substantial market share of all annuities sold in this country.
If you are in advanced years, a smoker or have impaired health (or have had impaired health in the past) you may be able to increase your retirement annuity income.
Some pension annuities, called "Enhanced Annuities" or "Impaired Annuities", pay more than standard annuities because those in better health tend to live longer than the average person. The annuity providers therefore have to pay out more over the healthier person's retirement so their yearly income is usually lower. This is why it's crucial to report any health problem to your adviser, no matter how small you think it is. It may get you a higher annuity rate of return.
This is also the case if you smoke ten or more manufactured cigarettes or use 85mg of rolling tobacco a day.
Even though you may regard yourself to be in quite good health, the reality can often be surprisingly different. Some think they have to suffer from a serious medical condition such as heart disease, cancer or stroke to receive extra annuity income, but a seemingly mild condition or complaint may substantially increase your annual retirement income.
In fact, if you have one of nearly 1500 ailments, such as being overweight, high blood pressure, asthma, rheumatoid arthritis, angina, heart problems etc., you must ensure you mention it to your adviser.
Additionally, higher annuity incomes are often achieved by:
• Those who have retired from certain occupations
• Those who live in certain parts of the country
It's estimated that up to 40 percent of the UK population could boost their annuity income with an "enhanced annuity". If you believe that you fit that category, it is extremely important that you tell our team of annuity experts about it. You will stand a better chance of a higher annuity income for the rest of your retirement.
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Pension Annuities for Smokers
If you are a smoker, annuity providers factor in that you are more likely to die sooner than the average person who doesn't smoke. They therefore assume that they'll not be paying your annuity to you for as long. A presumed shorter retirement lifespan therefore means that smokers can increase the amount of annuity income that they receive.
Annuities: Older Smoker
As a smoker, you may already be entitled to receive a higher pension income, but also, dependent on your age, you may receive further enhanced annuity rates of up to 30 percent above the standard level annuity rate. For example, if you normally would receive £1,000 per year as a non smoker, you could receive as much as £300 per year more as an older smoker.
In the case of enhanced annuities it can actually pay to be older and in poor health!
Annuities Up in Smoke
The average British smoker spends £92,000 on cigarettes in a lifetime, according to research by Clerical Medical, enough money to buy an annuity of approximately £6,000.
For each smoker that’s a breathtaking 373,302 cigarettes smoked and 18,665 packets purchased.
On a yearly basis that breaks down to £1,500 spent on tobacco, which works out to 6,060 individual cigarettes (303 packets).
In a day a smoker burns through 15.24 cigarettes, which in a week totals 106.68 – but with the normal smoker admitting to an increase in their usual daily quota when they go out, that weekly figure tops 116.
Annuity provider Clerical Medical's survey of 3,000 people found UK smokers collectively get through 72 billion cigarettes a year (3.6 billion packs), costing a shocking £17 billion. Laid out in a line all those cigarettes would stretch over four million miles, and circumnavigate the earth 154 times.
John Hiew, Managing Director of Clerical Medical, said: ‘’We all know about the health problems associated with smoking but we wanted to find about out the wealth implications associated with the habit.”
He continued, "It’s a staggering amount of money British smokers spend whichever way you look at it, and that’s a hell of a lot of disposable income just going up in smoke. If people were to consider putting the money they spend each month on cigarettes into a savings plan not only would they probably live longer, but they could have an extra income of thousands of pounds a year."
Even social smokers – who only light up when they go out to bars, clubs or restaurants – spend over £11,000 in a lifetime. Part-timers still manage to inhale 14.55 cigarettes a week, in a year that stacks up to 756 fags (37 packs), which equals £186 per year.
Clerical Medical's research also revealed that 83 per cent of respondents have tried giving up smoking at least three times. A third admitted that they lasted only a couple of days, while the same amount crumbled after two months, while 15 per cent managed a year. Startlingly one in ten people said they sparked up again after more than twenty years of resisting the temptation to smoke.
Northern Ireland folk emerged as the biggest smokers, ahead of Londoners and those from the North West.
In order, the following are the regions where you're most likely to be a smoker and therefore more likely to get a higher annuity:
1. Northern Ireland
2. London
3. North West
4. East Anglia
5. South West
6. Yorkshire
7. South East
8. Wales
9. Midlands
10. Scotland
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Pension Annuities for Females
1000's of women retire every week in the UK, but, in general, they'll receive a lower income from their pension fund than men. Women are penalised when they buy their annuity simply because of their biological difference to men.
Income from annuities for females are lower because of their presumed longer life expectancy. An individual's annuity income is dependent on the annuity provider's estimation of how long they will live. So on average, the same pot of pension money has to last longer for a female than a male and so therefore has to be spread more thinly over more years for females.
This fact alone makes it even more important that women choose the right pension annuity or annuity alternative and not just accept the often inferior one on offer by their existing pension fund holder.
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Unsecured Pension, Income Drawdown or Phased Retirement
If you're aged between 55 years and 74, you can choose an unsecured pension as an alternative to an immediate annuity purchase. Unsecured pensions are sometimes also known as phased retirement or income drawdown.
With unsecured pensions, you can take your tax-free cash element first (it can't be taken later), and the balance would therefore remain in your selected pension fund. However, there's an exception to this in the case of phased drawdown, where your tax free cash and income requirements could be combined.
You can now draw down a chosen amount of between 0 percent and 120 percent of the calculated single person's annuity value for the remaining fund. What is left can be converted into an annuity when you choose to end the arrangement. Unsecured pensions are definitely not a suitable option for all.
This type of retirement plan is suitable for those who have a relatively large pension fund that's usually over £100,000. It has a high investment risk, as your investment includes equity based funds. This may be more suitable to people wishing to defer taking their annuity, have another source of secure income such as a company pension, or wish to benefit from the greater flexibility and death benefits that this particular option provides.
The income levels available from the fund must be reviewed every five years to ensure they remain in line with UK HM Revenue and Customs limits.
In the event of the death of somebody in full drawdown, the spouse, partner or dependant have a choice of doing the following with the remaining fund:
• Purchase an annuity using all of the remaining funds
• Continue with the unsecured pension/income drawdown arrangement using all of the remaining funds
• Take the whole amount as tax free cash (subject to a 35% tax charge)
A potential advantage of deferring an annuity purchase by using income drawdown is that an annuity is based on your health at the time of purchase. Therefore if you were to suffer poor health during the drawdown period, you may then qualify for a higher annuity rate than you would have done when you entered the drawdown arrangement. These "impaired health" annuities are often referred to as enhanced annuities.
The disadvantage with income drawdown could be that if at the start you were drawing down the maximum income from the fund, you may have a lower amount left at the end (depending on growth) with which to purchase an annuity or alternatively secured pension. You must also keep in mind that your pension fund may fall as well as rise.
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Phased Drawdown
Phased income drawdown allows you to draw an income from part of the pension fund leaving the rest intact with the possibility of growth. Instead of all at once, you can take your tax free cash at intervals. If the remaining fund does grow, it means that you could have a larger tax-free lump sum than taking it all at once. This may be suitable for someone who is still working and paying tax or maybe somebody working part-time who doesn't necessarily need their maximum income.
Phased income drawdown allows you to vary the amount of income that you receive from your pension. This gives you some flexibility if, in the future, your circumstances change. This has an added advantage in that part of your pension fund has the potential to carry on growing in a tax favoured environment.
It's crucial that you obtain the appropriate level of advice before committing to this type of arrangement.
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Alternatively Secured Pensions
If you have not bought a pension annuity by your 75th birthday, another option is an alternatively secured pension. They're available to those who have reached 75 but don not want to buy an annuity with their pension fund.
The funds in an alternatively secured pension are invested in much the same way as an unsecured pension (income drawdown) and carry the same risk. You're able to draw a regular retirement income from your pension fund, although maximum income permitted is lower than that available from an unsecured pension. Death benefits are available should you die whilst using an alternatively secured pension, but the associated tax can be extremely high.
Although an alternatively secured pension works in a similar way to an unsecured pension, it has different rules and limits. Your annuity adviser will explain. Remember that annuity alternative investments can go down as well as up and are not guaranteed.
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With Profits Annuities
With profit annuities are an investment linked alternative to a guaranteed annuity.
With profits annuities, the income level is guaranteed, unlike standard annuities where the fund is invested in gilts. The pension fund is invested in the with profits fund of the chosen pension provider. The future level of income is dependent on the future investment performance of the chosen with profit fund. This means that a with profit annuity can involve a higher level of risk than a standard annuity. Your income could fall or rise depending on future bonus levels.
There is more flexibility available under a with profit annuity arrangement when compared to a standard annuity. For example, you are able to adjust your future retirement income levels within minimum and maximum parameters should your particular circumstances change.
For instance, a 62 year old man may have a greater need for income from their own pension arrangements for the next 3 years until they start to receive the state pension. They could therefore set the income from a with profit annuity at a high level for that period, before reducing the income once they begin to receive the state pension.
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Variable Annuities / Third Way Annuities
Although conventional annuities provide a guaranteed income, they are not flexible - you have to lock into current interest rates. Variable annuities offer a mixture of income and capital growth benefits.
You will receive some income guarantees, but these provide less protection than the guarantees of conventional standard annuities.
Variable annuities can also provide you with investment growth potential. If you choose a conventional annuity, you lock into the current gilt yields which underpins your guaranteed pension income, but with variable annuities it is possible to participate in any possible future growth.
Third way variable annuities aim to supply a level of secured pension income from an annuity whilst combining some of the flexibility of unsecured pensions (also known as income drawdown).
As these types of annuity products vary widely, it's important that you ask a qualified annuity adviser for further information.
It's also important to ask your annuity provider how strong the guarantee is if the company runs into financial trouble.
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The Argument Against Annuity Calculators and Rate Tables
(...and what the FSA say about comparing pension annuity rates and annuity calculators}
You may already have visited other annuity sites and used an annuity calculator or consulted an annuity rate table.
• Were you 100% sure that the information was in date?
• Did the calculator or table take into account all of the annuity products on the market or was it just a selection?
• Were the alternatives to annuities explained?
• Did you know that FSA registered independent annuity brokers may have access to a wider range of retirement annuity possibilities?
• Was it an individual annuity quote or just an illustration?
• Did the website promote particular providers over others as they were remunerated higher by some companies?
• Are the annuity providers able to pay to list their services higher up the tables, or maybe have their products shown in a different way?
• Did you know that the annuity rates may change before your application actually goes through? If you received a quote, was it guaranteed?
Updated by machines or humans?
Did those sites use 'screen-scraping' technology that retrieves and transfers information from other programmes?
According to Wikipedia, "Screen scraping is generally considered an ad-hoc, inelegant technique, often used only as a "last resort" when no other mechanism is available. Aside from the higher programming and processing overhead, output displays intended for human consumption often change structure frequently. Humans can cope with this easily, but computer programs will often crash or produce incorrect results."
But the site said it was up to date
Even if the annuity comparison table or annuity calculator was 100 percent up to date and correct, were you aware that the stated rates may have no resemblance whatsoever to the income that you'll actually achieve? This is because your annuity may increase due to circumstances as yet unknown to the site, i.e. your state of health, medication that you may be taking and whether you're a smoker or not. Some annuity providers even base your future income on your previous occupation or where you live, specifically, your postcode.
So let's say that you do eventually find a site where everything is up to date and works correctly; do you know at this stage whether you want a level annuity, fixed-rate escalating annuity or an rpi-linked escalating annuity? Also, have you considered your spouse's, partner's or dependant's percentage on your death? Have you considered an unsecured pension or variable annuity? There are a bewildering array of choices.
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Pension Annuity Rates FSA: What does the Financial Services Authority say about comparison sites?
Comparison sites have been heavily criticised in the media and by the Financial Services Authority (FSA) for their incomplete information and lack of independence. Consumers looking to compare annuities often do not realise that they are not getting the whole picture.
The FSA say "Some may only include products that the website can make money from in some way, for example if you click through to the provider." They also state that you should never buy a product solely on the basis of what you see on their own tables. They recommend getting advice before using their tables.
Can I Just Use What I've Learned Here to Buy an Annuity?
The annuities information on this website does not represent financial advice. You must consult an annuity broker for complete information. "The Argument Against Annuity Calculators and Rate Tables" is opinion only and you shouldn't rely on the information to make (or refrain from making) any decisions about buying an annuity or annuity alternative.
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Why Use an IFA to Buy an Annuity?
1. A broker may be able to secure a better annuity deal or annuity alternative than you may be able to achieve by yourself.
2. A broker is more likely to have access to a wider range of annuity possibilities from the providers than you have.
3. Due to brokers ongoing relationships with annuity providers, they may be in a better position to deal with any problems that may arise with your application.
4. You will have one point of contact should anything need prompt attention or go wrong.
5. Brokers work to a stringent set of guidelines and rules laid down by the Financial Services Authority (FSA) who regulate brokers' working methods and policies.
6. Annuity brokers have got an interest in recommending the correct product or service for your particular circumstances. They will not wish to fall foul of strict FSA regulations.
7. If you choose not to get FSA registered broker advice, you may not be able to get compensation through the Financial Services Compensation Scheme (FSCS) if you have a future complaint about the recommended product or service.
8. According to the ‘Fairness Index' produced by the Financial Services Research Forum at Nottingham University, IFAs are the most trusted practitioners in financial services winning the highest ratings on overall fairness. It places them significantly higher than building societies, investment companies and life insurers. The Fairness Index encompasses a wide range of points including impartiality, courtesy and communication.
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