Q&A: Buying an annuity
Independent financial adviser Rachael Hall answers key questions on buying an annuity
Buying an annuity is a final and irrevocable decision, therefore it amazes me why there appears to be so little information and guidance to hand for those on the brink of retirement. Recently, independent pensions expert Dr Ros Altmann called for a ban on non-advisory annuity sales.
Unfortunately, very few savers employ the help of financial advisers - despite the fact that since the Retail Distribution Review last January, annuity providers can now charge customers ‘commission’ for advice, even when no advice has been offered or taken by the customer.
In a bid to highlight these issues, the Association of British Insurers (ABI) has published, for the first time, examples of annuity rates offered by its members.
These illustrations are not to serve as ‘best buy’ tables or price comparison sites but rather simply to illustrate the disparity of rates between annuity providers which can be as much as 30% and thus demonstrate the benefits of shopping around. However, the industry has someway to go before it can claim reform.
What is an annuity?
Essentially, an annuity is an insurance contract that provides you with an income for life in return for your personal pension fund - e.g. additional voluntary contributions (AVC), freestanding additional voluntary contributions (FSAVC) or a stakeholder pension.
In most cases you are able to elect to take up to 25% of your fund as tax free cash (now known as pension commencement lump sum) and the remainder is used to secure an income.
How are annuity rates determined?
Annuity rates are linked to gilt yields and are underwritten at the time of your application. Annuity rates are based upon your age, postcode, health and other lifestyle factors, so you may receive an enhanced rate if you are older and/or in poor health.
What types of annuity available to me?
An annuity can be in the form of a conventional annuity or an investment-linked annuity:
- Conventional annuities provide income payments that are guaranteed by the annuity provider. Income can either be level, or can increase year-on-year.
- Income provided by investment linked annuities will fluctuate in value, offering both the risk and potential rewards of investment performance.
There are also flexible annuities available, which give you the ability to reduce the income drawn early on in order to take a higher income later on (or vice versa).
Let us look at an example of a 65-year-old male with a personal pension fund of £66,369. His existing pension provider originally offered him a conventional level annuity of £3,679 on standard rates. This was later enhanced to £4,458.20 after confirmation of his medical conditions. If we were to consider his annuity options on the open market the results would be as follows:
|Annuity basis||Annual income from a conventional level annuity||Annual income from an increasing annuity||Annual income from an investment-linked annuity|
*In order to sustain the maximum level of income from an investment-linked annuity, the provider’s own investment fund must a consistently-high level of investment return, and thus carries a greater degree of risk which it is not guaranteed. Therefore, a client must have a suitable appetite for investment risk and the capacity for loss. Selecting a strong provider is essential, as Equitable Life policyholders discovered to their cost.
Increasing annuities can be linked to growth in the RPI, CPI or fixed at a set level. These annuities represent a degree of risk for the provider and therefore the initial rates reflect this as prices are pitched at significantly lower values than a conventional level annuity, which means that it would take the client in the above example 13 and a half years before the increasing annuity would catch up to the income provided by the level annuity.
What will happen to my annuity income in the event of my death?
Various irrevocable decisions have to be made at outset, including whether to include a spouse or dependent’s pension, and any form of value protection or guaranteed period on death.
Each of these options will influence the level of income paid. For example, a personal pension fund of £29,557.93 for a 59-year-old female, based upon a single life level annuity of £1,541 would be reduced to £1,475 if this was taken out as a joint life annuity with 50% spouse’s pension.
Do I have to buy an annuity with my retirement fund?
No. Annuity purchase is no longer compulsory and there is an option called income drawdown, whereby your fund remains invested and you can draw a variable income from the fund, subject to certain rules.
Rachael Hall is a medical specialist independent financial adviser at Rutherford Wilkinson Ltd. The information detailed above is for information purposes only and must not be viewed as advice or recommendations as other criteria will be required for evaluation of individual needs.