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Annuities - a basic guide

Annuities are paid out gradually, so you can't blow it on a year's safari

Women tend to get worse annuity rates than men

“I advise you to go on living solely to enrage those who are paying your annuities. It is the only pleasure I have left.” Voltaire

The Government - and you won't be surprised to hear this - doesn't trust us. It doesn't trust us not to blow the entire amount of our retirement fund on a world cruise or on Pretty Boy in the 3.30 at Sandown. If the Government did trust us not to do any of these things and we let them down, then they would end up having to feed and house us and that's why they are very keen on us buying an annuity with the money we have gathered in our pension funds.

Annuities are basically a kind of insurance payment that we get every month for the rest of our lives. The company that pays out this annuity promises to pay a certain amount every month for as long as we live – whether that be another two, twelve, twenty or two hundred years (unlikely but you never know).

Naturally, they don’t want to lose money so the longer they think you will live, the less they want to pay each month because the longer you live, the more they will end up shelling out. This is why women tend to get worse annuity rates than men and the older you are when you retire, the better your annuity rate will be. Smokers get a better annuity too, so it’s a really good idea to take a packet of Senior Service into the insurance company’s office when you go to sign up for yours. Develop a nasty hacking cough for a while too and you could get more money!

We can and should shop around for the highest rate possible.

With the basic annuity, an insurance company effectively takes your money and uses it to buy some low-risk assets such as gilts. It has to do that because it has to guarantee your income (and be confident of making a profit, albeit small). But you may be looking at twenty, thirty or even more years of retirement (let’s hope so), and that sort of investment tends to be paltry over that long a period.

Annuity rules have been changed, along with various pension regulations. It used to be that you had to take an annuity by age 75 but that no longer exists. Instead you have the option of taking what is called an ‘alternative secured income’ instead. This could mean that you can pass on any unused pension after your death. However, you will still have to take an annual income from your fund which will be taxed (as annuities are anyway).

There are also, now, two new types of annuity – the limited period annuity and the value-protected annuity.

The limited period annuity lasts for five years after which you can either buy another one or a normal lifetime annuity.

The value-protected annuity will give you a lower amount each month than a normal annuity but it will pay out any unused amount to your heirs so it’s useful if you want to pass on money to a partner or children on your death.

With any type of annuity, there are some basic rules you need to follow:

There are no two ways about it: you need to shop around. Don’t just take the annuity offered by your pension provider. What are the chances this will just happen to be the best value? It’s possible, but highly unlikely. Sadly this is what most people do and they miss out on extra money for years.

It’s worth looking for index-linked annuities, which will rise according to inflation. Although your starting payout will be smaller, you’ll get more each year to keep up with the changing value of money.

The two most influential factors on the size of your annuity are your age, and interest rates. The older you are, and the higher interest rates are when you buy, the bigger your annuity will be. This can be worth bearing in mind if you’re considering using income drawdown or phased retirement to delay purchasing your annuity.

Although your pension savings were tax free, you have to pay tax on the income you get from the annuity. Keep that in mind when working out your budget.

Remember, if you are not getting enough to live on through your annuity, you should be entitled to some rather useful Pension credits.

Jasmine Birtles and the Moneymagpie
Moneymagpie Moneypedia
14.06.2007