Annuities: The Options Available
There are a variety of options available when you buy an annuity and it is important you understand the choices they provide as once you have selected an annuity, it is unlikely you will be able to change your mind. Which options will suit you will depend upon your circumstances and attitude to risk and we would recommend you take advice if you are at all unsure.
This type of annuity, the simplest to understand, provides you with the highest level of income from the outset compared to all other options. The pension is set at a level and remains in payment at this level as long as you live. As time goes by, the value of the pension, in real terms will decrease. If you retire early and then live a long time (a good thing), this reduction in 'buying power' will be considerable dependant on inflation.
This helps provide for your partner on your death by continuing to pay the income until your partner dies. Depending on the option selected, either a full or reduced level of income will continue to be paid to your partner. A partner several years younger than you could significantly reduce the income payment offered at outset. Joint life annuities are often taken out by married couples, especially when the spouse has no other independent pension income. Joint life annuities can also provide for other dependents who are financially dependent on the annuitant. The younger the age of the second life, the more expensive the option will be.
If you were to die in the first few years of taking an annuity you would effectively lose all your money for nothing. Many annuities provide a guaranteed period typically 5 or 10 years. If you die before the end of the guaranteed period, the annuity will continue to be paid to your partner or estate up to the end of the guaranteed period. If the annuity is on a joint-life basis and both parties die within the guaranteed period, the payments will be made to the annuitant's estate.
The level of the annuity will increase annually at a predetermined rate. This can be fixed as a percentage or linked to an index such as the retail price index. This provides some protection against inflation however the initial income will be significantly reduced in comparison to a level annuity.
With or without overlap
Only applicable to a joint life guaranteed annuity. If the annuity is provided with overlap, then if the annuitant dies, the spouse & dependent's pension will commence immediately upon the annuitant's death. Without overlap, the pension will commence at the end of the guaranteed period or immediately upon the annuitant's death, whichever occurs latest.
You can normally opt to have income paid monthly, quarterly, half-yearly or annually although the vast majority are paid monthly. They can also be paid in advance or in arrears. Arrears will provide a slightly higher level of income.
With-Profits & Unitised Annuities
Traditional annuities provide a guaranteed income. With-profits & unitised annuities allow you to share in some upside with a reduced guaranteed element over what a traditional annuity will provide.
A with-profits annuity provides a low level of guaranteed income and then an annual bonus is payable from the with-profits fund. The funds are normally smoothed so an element of increased annuity is given in most years. The level of income is dependent upon the success of the With-Profits fund.
Under a unit linked annuity, the income received is dependent upon the underlying performance of the fund selected which will undoubtedly fluctuate over time with market conditions. This can lead to a higher level of income in the long-term but very little in the way of a guarantee somewhat defeating the object. If you are prepared for this level of risk, then an annuity probably isn’t the right answer.
The main benefit of an annuity is that they are guaranteed but that guarantee usually comes at a very high price. The main downsides of an annuity are its inflexibility to cope should your circumstances or tax legislation or inflation change.
Other downsides to consider are –
- If you die in the early years of the policy unless you have chosen a joint life annuity and/or a guaranteed period you will get back much less than you paid for the annuity.
- An annuity generally has no cash in value although the chancellor is looking to introduce a second-hand market in annuities from April 2016. It is unlikely that this will be good value for most annuitants.
- The spending power of an annuity can be quickly negated by high levels of inflation.
- Changes in tax rates can affect you but your annuity will continue to be paid even if tax rates increase and there is no flexibility to avoid the additional tax.
- It is unlikely you will be able to alter or remove any of your annuity options.
We can help advise you on which options may be right for you and also discuss whether an annuity is the right option at all. Recent changes in pension legislation mean that there is now considerable flexibility over how you can spend your retirement savings. See New Rules About Pensions.
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