Product Library: Annuities

There are several ways of turning your pension fund into a regular income for your retirement. The government sets rules about how you can do this. The usual way is to take a tax-free lump sum and then use the rest of the fund to buy a lifetime annuity from a life insurance company. This turns your pension fund into a pension income for the rest of your life.

Annuities are offered by Life Insurance companies. They calculate the annuity rates they offer by taking account of the fact that some people will live longer than others. Obviously, people who live longer than average will take more from their annuity than, for example, somebody who dies three or four years after retirement.

People who die early subsidise the annuity rates for those who live longer but everyone benefits from the payment of an income throughout their retirement, no matter how long or how short that proves to be. Insurance companies adjust rates because average life expectancy is rising and people are living longer.

Interest rates also affect annuity rates because they determine the returns on the investments from which insurers pay annuities.

The main factors which will affect the amount of annuity one can purchase are as follows;

• The amount you have in your pension fund (after Pension Commencement Lump Sum)
• Your health
• Your age
• Your sex
• The benefits you choose, such as whether the annuity is for you or for you and your partner

The older you are when you buy an annuity, the higher will be the income you get from it at the start. This is because, on average, an older person has fewer years left to live a younger person. So, an older person’s pension fund does not have to last so long.

There are different types of annuity to suit your needs and circumstances. The basic types are;

• Single life – an annuity just for you if you don’t have a spouse or partner or, if they do not rely on you for income.
• Joint life – an annuity that will pay out to your spouse or partner of your death.

You can also choose whether you want annuity to be;

• Level – the amount of annuity will remain constant throughout life, taking no account of inflation.
• Escalating – the initial amount of annuity is lower but increases as each year passes to take into account the effects of inflation.
• Guaranteed – the annuity can be guaranteed for the first five or ten years so that, in the event of a early death, some of your capital is preserved.

The level annuity offers the most attractive income and each option that is built in to the plan reduces the initial annuity payment.

Whatever happens, once the annuity has commenced, it cannot be changed. It is therefore a very inflexible structure and is unable to adapt and should or circumstances change in the future.

In addition, the annuity represents a capital risk in that once the annuitants have died, any remaining capital is retained by the insurance company and is effectively used to subsidise future annuitants.

So, the advantages of the annuity are;

• A guaranteed income for the rest of your life
• Certainty of income
• Improved rates for impaired lives

The disadvantages are;

• The capital risk of early death. Effectively, the annuity dies when you do
• Inflexibility in the event that circumstances should change
• You may purchase your annuity at a time when annuity rates are low and you have therefore locked in to a poor income
• You have to make decisions about the future at a relatively young age
• If you buy a spouse’s annuity at the outset, and your spouse dies before you, the benefits will be lost.

In other words, one has to make a decision at retirement age, which will provide a guaranteed level of income but which cannot be altered to reflect changes in circumstances. Annuities carry a degree of capital risk and you should be aware that there is no return of capital on death, and wealth cannot be passed on to dependants.

If you would like any further help or information on any aspect of retirement, please use the 'contact us' feature, or call on 01727 734040.