Annuities – What are they?
When you reach retirement, the pension fund you’ve been paying money into doesn’t automatically start paying you an income. You have to convert it into a product that will. Pension annuities are one of these products.
A Pension Annuity converts your pension savings into a secure income for your retirement no matter what happens with the stock market or interest rates. You can buy an annuity any time after age of 55. Annuities can also be bought using your own funds (e.g. from savings), which are sometimes called Purchased Life Annuities. At WhoPaysMost.com we deal with Fixed Term, Purchase Life and Pension Annuities which are bought using money from a UK pension scheme.
If you are interested in any other type of annuity or another retirement product, you should seek specialist financial advice. You may also find the Money Advice Service website useful – http://www.moneyadviceservice.org.uk/yourmoney/
How is an annuity calculated?
Basically, the insurance company (annuities provider) that sells you the annuity, estimates how long they think you’re going to live and works out how much they will pay you each year. This income is then guaranteed for the duration of the annuity, which in the case of a lifetime pension annuity is for the rest of your life.
Annuities can also be tailored to meet your individual requirements with a range of options including:
- Single or Joint Life
- Guarantee Period
- Escalation (Annual Increase)
- Value Protection
- Payment Frequency
These annuities options will change the amount you will be paid by the provider, with the general rule being the more options you add, the lower your initial annual income will be. The addition of each annuity option alters the amount you will be paid by varying degrees. The table below gives you an indication of the difference that each annuity option makes.
Annuities – The Big Picture
The reason for this service is to help customers increase their retirement income.
It is designed to give customers a straightforward way of getting information which could mean they are financially better off in retirement.
Because we are a guidance only service, we explain everything simply and factually, so you’re able to weigh up the pros and cons of each option.
‘Small’ Pension funds
The vast majority of people in the UK with a private pension fund have what is commonly known as a ‘small pot’. A ‘small pot’ can be anything from a few thousand pounds up to £50-60,000. Often people with these so-called ‘small pots’ aren’t able to get independent financial advice as they may find that they have to pay fees that make it unaffordable. This may be one of the reasons why thousands of people don’t look around for a better deal and just accept the annuity that’s offered to them by their pension provider. As this is often not the best annuity rate available, it can sometimes mean they miss out on thousands of pounds over their lifetime.
Buying an annuity is a one-off purchase and an annuity can’t be changed, cashed in or moved somewhere else once it’s set up. Because of this it’s one of the most important things you’ll ever buy. Even pension funds that some people may describe as ‘small’ can represent tens of thousands of pounds that you’ve saved up for a long time, so it’s a decision that should be taken seriously.
The Open Market Option
Government legislation states that you don’t have to buy your annuity from the same company that you have your pension fund with; it’s called the Open Market Option. The Open Market Option means you’re free to shop around and find the best annuity rate you can. If you find a better annuity rate than the one your pension company is offering you, you’re entitled to buy your annuity from there.
Your pension company will send the money to the new annuity provider and your annuity income will be paid by them. Every pension provider that offers annuities has a different rate. Some of these can be good, but some are very poor compared to what is available on the open market. Whether or not you’re offered a good deal by your pension provider depends on who your pension is with.
REMEMBER, if you’re buying a lifetime pension annuity, the extra income you receive by shopping around is paid out for the REST OF YOUR LIFE. Or to look at it the other way – not shopping around means you could miss out on extra income for the rest of your life and there’s nothing you can do about it. You can only buy an annuity once so it’s important to get it right.