Taking greater responsibility for your financial future

On 9 December 2010, the Treasury published its draft Finance Act legislation which explained the way pension benefits would be taken in the future. Annuities themselves have not been changed; however, it is now possible to buy an annuity at any age after 55. An annuity will still be the option of choice for most retiring investors because, unlike drawdown, it provides a secure income for life. Annuities are to be used to secure the minimum income requirement of £20,000 to allow investors to use the rest of their pension to go into Flexible Drawdown.

Choosing the right annuity at the start is very important as once you have bought your annuity you cannot change your decision. In order that we make the right recommendation to you it is important, therefore, that all your circumstances and requirements are taken into consideration.

An annuity is a regular income paid in exchange for a lump sum, usually the result of years of investing in an approved, tax-free pension scheme. There are different types. The vast majority of annuities are conventional and pay a risk-free income that is guaranteed for life. The amount you receive will depend on your age, whether you are male or female, and the size of your pension fund and, in some circumstances, the State of your health.

Your pension company may want you to choose its annuity offering, but the law says you don’t have to. Everyone has the right to use the ‘Open Market Option’, to shop around and choose the annuity that best suits their needs. There can often be a significant difference between the highest and lowest annuity rates available.

Some insurance companies will pay a higher income if you have certain medical conditions. These specialist insurers use this to your advantage and will pay you a higher income because they calculate that, on average, your income should be paid out for a shorter period of time.

The annuity rate you receive will depend on several factors, for example whether you require:

a joint life or single life policy

want the policy to be index linked to increase in line with inflation

whether you have any health or lifestyle considerations

whether you wish to take the 25 per cent cash tax-free as a lump sum from your pension fund
Some older pension policies have special guarantees that mean they will pay a much higher rate than is usual. Guaranteed Annuity Rates (GARs) could result in an income twice or even three times as high as policies without a GAR.

A conventional annuity is a contract whereby the insurance company agrees to pay you a guaranteed income either for a specific period or for the rest of your life in return for a capital sum. The capital is non-returnable and hence the income paid is relatively high.

Income paid is based on your age, for example, the mortality factor, and interest rates on long-term gilts, and income is paid annually, half yearly, quarterly or monthly.

Annuities can be on one life or two. If they are on two lives, the annuity will normally continue until the death of the second life. And if the annuitant dies early, some or all of the capital is lost. Capital protected annuities return the balance of the capital on early death.

Payments from pension annuities are taxed as income. Purchased life annuities have a capital and an interest element; the capital element is tax-free, the interest element is taxable.

Types of annuity

Types of annuity include the following:

Immediate annuity
The purchase price is paid to the insurance company and the income starts immediately and is paid for the lifetime of the annuitant.

Guaranteed annuity
Income is paid for the annuitant’s life, but in the event of early death within a guaranteed period, say five or ten years, the income is paid for the balance of the guaranteed period to the beneficiaries.

Compulsory purchase
Also known as open market option annuities, these are bought with the proceeds of pension funds. A fund from an occupational scheme or buy-out (S32) policy will buy a compulsory purchase annuity. A fund from a retirement annuity or personal pension will buy an open market option annuity, an opportunity to move the fund to a provider offering higher annuity rates.

Deferred annuities
A single payment or regular payments are made to an insurance company, but payment of the income does not start for some months or years.

Temporary annuity
A lump sum payment is made to the insurance company and income
starts immediately, but it is only for a limited period, say five years. Payments finish at the end of the fixed period or on earlier death.

Level annuity
The income is level at all times and does not keep pace with inflation.

Increasing or escalating annuity
The annuitant selects a rate of increase and the income will rise each year by the chosen percentage.

Some life offices now offer an annuity where the performance is linked to some extent to either a unit-linked or with-profits fund to give exposure to equities and hopefully increase returns.

Did you know?
Many people are unaware that they have the right to shop around for a different annuity provider, to provide them a pension income for their retirement. By shopping around, you could get a better annuity rate for your pension fund! This is known as an ‘Open Market Option’ and it can make a significant difference to your retirement income.