Annuity Factsheet from Midlands Investment Agency
Do you have to buy an annuity when your retire?
You do not have to buy an annuity at your retirement date. You can continue paying into your pension fund and buy an annuity at a later date to suit you. Even if you do not make any further payments, your fund will remain invested.
You do not have to stop work because you buy an annuity.
If you decide to delay buying an annuity, you will need to be sure that you have enough income in the meantime.
What is an annuity?
An annuity converts your pension fund into pension income – and is the only means of providing a guaranteed income for life, regardless of how long you live. You buy an annuity from an insurance company with your pension fund. The pension income from your annuity is taxable.
What types of annuity are there?
There are different types of annuity to suit your needs and circumstances. The basic types are:
- An annuity just for you – known as single life. If you do not have a partner, or if they do not rely on you for income (they have their own resources for example), this could be suitable for you.
- An annuity that will continue to be paid to your partner after your death – known as joint life. If your partner does not have their own pension arrangement and they rely on you for income, this could be suitable for you.
You can also choose whether you want the income from your annuity to:
- stay at the same amount every year – a level annuity
- increase each year for example, to keep up with inflation or by a fixed rate – an escalating annuity
- be guaranteed for a minimum number of years so that it will continue to pay the income (usually to your partner or estate) if you die before the time period is up – a guaranteed annuity.
You may be able to benefit from an enhanced annuity or an impaired life annuity, which pay a higher income, depending on your lifestyle or state of health. Generally, if your lifestyle or health is such that it may reasonably be expected to shorten your life, you could get a higher income from your annuity.
How is an annuity worked out?
The most important factors that affect the income you will get from your annuity are:
- the value of your pension fund when you retire
- the amount of any tax-free lump sum you decide to take – this will reduce what you have left in your fund to buy an annuity
- the annuity rate offered by the insurance company – annuity rates vary from company to company
- the type of annuity you decide to buy – joint or single life, level or escalating, guaranteed for a minimum number of years
- your age and life expectancy
- your sex – annuities for women cost more, as they usually live longer than men
- your health – some companies will pay higher annuities to people who smoke or who are in poor health
Where can you buy an annuity?
Annuities are bought from insurance companies and you can buy one from any insurance company you choose in the UK. This is called the ‘open market option’ and it is especially important as it allows you to get the pension most appropriate to your own circumstances. It could mean that you get the highest pension income available from the market when you choose to buy an annuity. You may however find it difficult to benefit from the open market option if you have a very small pension fund, say below £5,000.
How can you find the right deal?
We will tell you how much your pension fund is worth and how much income we can arrange for you. To do this we need to know what sort of annuity you are looking for, when we will research the market to find the best terms.
Annuity quotes are usually fixed for a limited period, between 7 and 21 days, during which time you will need to make your final decision, complete the paperwork to set up your annuity and arrange (if necessary) to transfer your pension fund to the new company. Once you decide to accept an annuity quote, you will have a 14-day ‘cooling off’ period in which to cancel, if you change your mind.
You have some important choices to make – choices which affect the amount of pension income you will get for the rest of your life. We strongly suggest you discuss these choices with us so we can help you with your decision.
Once you have bought your annuity you cannot switch to another provider or a different type of annuity at a later date.
If you have contracted-out of the additional State pension scheme
If you have used your pension plan to contract out of the additional State Earnings Related Pension Scheme (this was SERPS but is now the State Second Pension), you can use this part of your pension fund to buy a joint life annuity if you are married at the time you retire.
What other options are there?
You do not have to buy an annuity, but it is very re-assuring to know that your income is guaranteed for life, which is only available from an annuity.
If you do not want a type of annuity mentioned earlier and are prepared to forego income security, or if you decide to delay buying an annuity, there are other options you might consider.
Phased Retirement
Depending on your pension plan, you may be able to split your pension fund into a number of slices and buy an annuity with each slice at different times over the years.
Flexible Drawdown
This is a way to draw a variable income from your pension fund while it remains invested and delay using it all to buy an annuity. This option is available provided the minimum income requirement (MIR) can be met. The MIR has been set at £12,000 a year and is designed to ensure individuals who withdraw large amounts from their pension fund, have enough income left to live on without resorting to State support.
Capped Drawdown
This is another form of income provision from your pension plan where the fund remains invested. You are able to select a specific amount of income to a maximum level set by the Government Actuaries Department (GAD). The notional annuity is based upon your age, gender, size of fund and prevailing long-dated gilt yield at the time of calculation. The income level that you choose initially can be altered at any time, provided the revised amount remains within the GAD limit.
Fixed Term Annuities
A fixed term annuity (FTA) is a drawdown plan which provides guaranteed income payments for a set number of years, at the end of which time there will be a lump sum payout. This must be invested in either another FTA, a drawdown plan or a lifetime annuity. Most FTAs provide a guaranteed maturity value and some have the option of a return linked to equities.
NB
Income drawdown in its various forms are complex arrangements, where the income and investments can fall as well as rise in value, so you could get back less than you invest.
