Who needs a boring old annuity now that – from April 2015 – we will have the new pension flexibility? That must be the question many people are asking themselves, especially those heading towards the “magic 55” mark when they can choose where to convert their pension pot into a much wider range of products… except that those choices are still being developed!
But “boring old annuities” are likely to retain an appeal even after those new products come on the market, for the simple reason that they do fill a niche: providing a guaranteed income for a large part or all of your life, regardless of what else comes and goes in the money market.
And while there have been (understandable) complaints about their performance in recent years, at times of ultra low inflation that performance doesn’t look quite so shabby.
Moreover, if you look around, (usually beyond the immediate horizons of your own pension provider) there are many different types of annuity available – some enabling you to add an element of risk and return as well as greater flexibility.
So what are annuities, how do they work, and what choices do you have?
When you come to the end of your employment (or reach 55 or older) you are currently allowed to take a portion of your pension pot (or individual pension pots) out in cash (typically 25% but sometimes more); the rest (until now) has had to go into an annuity that provides an income for the rest of your life. That amount can be varied to take account of inflation, or even contain an element that allows your spouse, civil partner or dependent child to carry on receiving it after your death.
Whoever takes on your business is essentially making a calculated risk as to how long you are likely to live, and that will be based on a cocktail of factors. If you go past that date, you are likely to be the “winner” in terms of total returns, and vice versa.
If you have been leading an unhealthy life, for example by being a smoker or heavy drinker, or have a medical condition, you can significantly improve the amount you receive by applying for an enhanced annuity: the upside of having a shorter life expectancy!
There are several types of annuity available, principally:
Fixed term annuities provide an income for a fixed period rather than for life, together with a lump sum at the end of that period.
Investment-linked annuities offer more risk and a chance of higher returns – albeit with a base level of guaranteed income. More suited to those prepared to take their longer term chances with the stock market.
Income drawdown plans are well worth looking at if you are retiring before April 2015 and want to “hedge your bets” about what might come onto the market. You are allowed to take an income but your investment pot remains intact.
And here are some other variations to consider…
Joint life: Here your spouse or civil partner will continue to receive a percentage of your payments after your demise in return for a reduction in the amount you receive during your life.
Fixed and increasing incomes: Choose between a fixed income for life, or build in a fixed increase to allow for inflation.
The decision to where to invest and what sort of policy would really suit you best is critical, so do take independent, expert advice. And be prepared to research the market rather than simply accepting the best offer from your current pension provider.