Annuity rates are crucial. It’s essential you get the best annuity rate once you retire because once you get it you’re stuck with it. Here’s how to get the best annuities whatever your circumstances

• What is an annuity?
• How much will you get?
• What are the options?
• Getting started

What is an annuity?

An annuity is a financial product providing you with a specific income for life in retirement. You hand over your pension to an insurance company in exchange for a regular income paid until you die (or longer if you opt for a guranteed period – see below). As with any insurance product, the provider will hedge their bets and 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 lower annuity rates than men and the younger you cash in your pension pot the less you will be offered because the annuity companies assume they will have to shell out for a lot longer. As Voltaire said, “I advise you to go on living solely to enrage those who are paying your annuities.  It is the only pleasure I have left.”

Do you have to buy one?

In short, the answer is no, you don’t have to take out an annuity right now.

Since April 2011 those in retirement are no longer forced to buy an annuity by the age of 75. This gives you greater flexibility to decide when you will take out an annuity so if rates are poor and you can afford to wait until markets pick up, for example, you will no longer have the compulsory deadline hanging over you.

Also, if you decide you don’t want to buy an annuity, you can instead opt for an ‘income drawdown’ plan which leaves your pension pot invested and continuing to grow as you see fit whilst you take a small income from it. There will be a cap on the amount you ‘drawdown’ but the details of these figures are still being decided.

How much will you get?

Apart from the size of your pension pot and your age, the most influential factor on the amount you get from your annuity are the interest rates available at the time. Now this is the really crucial bit. Do NOT just stick with whatever your existing pension provider offers before taking what is known as the Open Market Option (OMO). More often than not you can find a much better rate elsewhere so always, always, always take the time to shop around. Do NOT bow to pressure from your pension provider because they will certainly try to get you to sign on the dotted line with them quite early on.

Sadly most people fail to do this and miss out on extra money for years – in fact you could increase your annuity rate by as much as 30% by comparing rates so it really couldn’t be more important.

There are various ways you can compare annuity rates:

• The Financial Services Authority has an independent annuity comparison service
• You can compare best buy rates from various providers with Hargreaves Lansdown.
• You can also speak to a specialist independent pensions adviser who could show you the options.

Annuity rates are shown on pensions tables either as a percentage, or as £s per £10,000 you have invested, for example, an annuity rate of 5% is the same as £500 a year income for every £10,000 in your pot. When you’re comparing different products that’s how you can see which are paying the best.

Remember that although your pension savings were tax free, you now have to pay tax on the income you get from the annuity (it’s a cheek but there we are). Keep that in mind when working out your budget and remember, if you are not getting enough to live on through your annuity, you should be entitled to some rather useful Pension Credits.

What are the options?

There are lots of variations when it comes to annuities so you’ll need to sit down (with your family…or at least a glass of something fortifying), weigh them all up ask yourself the following questions:

Do you want your annuity to pay an income to your partner when you die?

If you take out a Single Life annuity, that income will only be paid throughout your life so when you die, the payments stop and the insurance company pockets most of what’s left. By the way, if you are the wife or husband of someone who is thinking about getting an annuity you need to be part of this decision because it will affect you particularly.

If you have a partner it is well worth considering a Joint Life annuity instead which will continue to pay an income to them should you die first. The payout will be reduced because the insurance company is likely to make payments for longer but if your wife or husband is financially dependent it is a necessary sacrifice. You can choose how much of that income is paid – typically from 50% up to 100% of your original pension value.

If you don’t have a Joint Life Annuity you can still ask to have your payments guaranteed. This means that your income will be paid for a fixed term, usually of five or ten years, even if you die within this period to avoid losing the bulk of your fund should you die shortly after taking out an annuity.

Do you want your retirement income to remain at the same level for life?

If you’re concerned about inflation and how it’s going to eat into the spending power of your money in later years, it’s worth looking for an Index-linked Annuity. These annuities rise in line with the Retail Price Index (RPI). There are pros and cons to this:

• On the one hand, if inflation goes up (as it is highly likely to) your money will keep pace with it so that you can keep on spending, roughly, the same as the years go on.
• On the other hand, you get offered a lower starting payout and it will stay lower for a few of the first years.
• Also, most index-linked annuities lag behind the RPI announcements by a few months so you don’t get your increase as quickly as you would like.

Alternatively, you can choose an annuity which rises by a fixed amount each year, for example 3%, to counter the effects of inflation. The advantage of this type is that you will get a rise whatever happens. However, if inflation rises by a lot more than you assumed you will lose out.

Do you have any medical conditions, or have you ever smoked?

If you smoke, or have a personal/family history of any medical conditions you may be able to take out an Impaired Life or Enhanced annuity which offers higher income because your life expectancy is shorter. You will need to undergo a medical or provide evidence of your condition but there are over 1,500 conditions including high blood pressure, diabetes, heart conditions and certain types of cancer that are included, so it’s worth investigating. It’s one of the few occasions in life where it’s actually worth looking ill for a bit!

Do you want to convert your pot in stages?

You could try Phased Retirement. This is where you use part of your fund to buy an annuity and the rest of it remains invested. At a later date you can use another chunk of your pension pot to buy another annuity and, crucially, each time you convert part of your fund, you can take your 25% tax-free lump sum first. This is only really an option if you have a fairly large pot because insurance companies  set a minimum fund size but this can be useful if you’re cutting back on work bit by bit and want to make the transition as you go.

Another option is a Limited Period annuity which lasts for five years, after which you can either buy another one or a normal lifetime annuity.  If annuity rates have improved or your health deteriorates, you could get a better deal but if rates have fallen (and annuity rates have taken a downward spiral over the years) you will get less.

Do you want an investment annuity?

If you’re still happy to take on risk with your annuity you can invest your pension fund into either the insurance company’s with-profits fund or in units in investment funds) and hope to benefit from stock market rises. There is of course also the risk that the value will fall so do get advice before taking this route.

Frankly, whatever you do it’s a bit of a gamble. The best way to go forward is to do as much research as you can, take advice from an independent adviser and pick the option that seems the most sensible to you.

Getting started

If you are going to a buy an annuity it is going to be one of the most important financial decisions of your life and you can’t undo it so it is a good idea to seek some professional, independent advice before taking the plunge.  Go to Unbiased where you simply enter your postcode to find Independent Financial Advisers (IFAs) close to you.