Navigating The Annuity Minefield
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A Selection of Possible Annuity Providers
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A Selection of Possible Annuity Providers
Annuities are not the only fruit
Alternatives to Annuities are Available
Your qualified consultant can assist you in making optimum decisions for such investments, and would be happy to provide comparative illustrations of the options below.But first, what actually is a pension annuity?
A conventional pension annuity is an arrangement where you make a lump-sum investment. From this investment you'll receive a guaranteed level of income. There are also alternative forms of annuities that provide a greater degree of flexibility. Most annuities are bought using funds held in money purchase pension schemes.
So basically, an annuity converts a savings fund into income and that income will be paid to you as long as you live.
An annuity is payable for your lifetime after purchase, although it's possible to select a fixed period if purchasing an annuity with cash rather than pension funds.
An example of this type of "Compulsory Purchase Annuity" is a conventional annuity, with profit annuity and unit linked, or 3rd way annuity. An annuity that's purchased from savings, not from a pension scheme is referred to as a Purchase Life Annuity or Immediate Vesting Annuity.
You are normally entitled to take up to 25 per cent of your pension fund as tax free cash. Your annuity will be treated as pension income under "pay as you earn" tax rules.
This could be one of the biggest financial decisions you'll ever make, so ensure that you maximise your income. Once you buy an annuity you can not change your mind so you need to make sure you get it right first time.
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Types of Annuity: Tailored to suit you personally
There are a wide range of options which can be selected when choosing an annuity plan. The most widely used options are listed below.Minimum Term
Income is guaranteed to be paid until the death of the annuity holder, but it can also be modified to include any of the following options:
• 5-year guarantee - annuity ceases at death of annuity holder, or after 5 years, whichever is the longer
• 10-year guarantee - annuity ceases at death of annuity holder, or after 10 years, whichever is the longer
• Joint life annuity - annuity ceases on the death of the second of two named annuity holders
Spouse Benefits
Your spouse, partner or dependant can be protected after your death by choosing one of the following options:
• Reduction to half benefit,
• reduction to two thirds benefit or
• full benefit
The annuity is thus adjusted to the new level at the death of the annuity holder or at the end of the guarantee period (if selected) and continues until the death of the spouse, partner or dependant.
Escalation
An annuity can either be paid at a fixed level or can include an escalation at 3%, 5%, or at the RPI percentage (annual increase in the retail price index). You can thus choose to compensate for any inflationary effects on your income. However, your initial income level will be reduced if you choose escalation. Your specialist annuity adviser can look at a range of options for you to help you decide on the best option for your individual circumstances.
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Purchased Life Annuity: An annuity with a difference
A purchased life annuity is an annuity purchased with your own funds, as opposed to from a money-purchase pension fund. It operates in the same way as a compulsory purchase annuity, but it does have tax advantages.The entire pension that you receive from a compulsory purchase annuity is treated as taxable income in the same way as income from any normal employment would be. However when you buy a purchased life annuity, that part of the annuity income, which is calculated as capital repayment to you, is tax-free. Only that part of your annuity income that is interest paid on your investment is taxable.
With similar annuity rates, the effect of this tax treatment of a purchased life annuity, for a basic rate tax payer from a £200,000 investment would be to increase their net income by approximately £200 per month.
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Take advantage of The Open Market Option
The Open Market Option allows those who retire to shop around for different ways to convert their pension funds into an annuity, as opposed to just accepting the rate offered by their pension provider.When your pension fund reaches maturity, your pension provider will advise you of the fund value and give you general information about annuities and the level of annuity income you would receive.
You are then entitled to use your Open Market Option, which allows you to transfer the pension fund value to another annuity provider of your choosing. This enables you to take advantage of a higher annuity income which may be available from a different provider. Annuities are usually provided by insurance companies.
You could receive more income from a pension annuity than you think. The Financial Services Authority (FSA) agree; they say "You may be able to get a better annuity rate by shopping around. You should check what your provider is offering you and then compare this with the annuities on offer through the open market."
However, many retirees still do not use their Open Market Option. This is not just because they are unaware of the benefits of doing so, but they don't actually realise that they have an option. It's been claimed that those at retirement who do not use their option, taking the default annuity offered by their pension provider, may be missing out on up to 40% more income.
According to the professional pensions publication, DC World, it is estimated that over £1 billion in pensions was lost by failure to get proper advice on the best-selling annuity.
To make the most of the Open Market Option it is important that you speak to an Independent Financial Adviser (IFA) who will explain the different retirement options available.
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Enhanced Annuities / Impaired Annuities
If you're in advanced years, a smoker or have/have had impaired health you may be able to increase your annuity income.The reason why some pension annuities, called "Enhanced Annuities" or "Impaired Annuities", pay more than standard annuities is because those in better health tend to live longer than the average. The annuity providers therefore have to pay out more over the healthier person's retirement lifetime so their yearly income is usually lower. This is why it is extremely important to report any ailment, no matter how small you think it is, to your adviser. It may get you a higher rate of return.
This is also the case if you smoke 10 or more manufactured cigarettes or use 85mg of rolling tobacco per day.
Even though you may regard yourself to be in relatively good health (some think they have to suffer from a serious medical condition such as cancer, heart disease or stroke to receive extra income in retirement), the reality is often different. A seemingly minor condition or complaint may substantially increase your annual retirement income.
In fact if you have one of nearly 1500 health conditions, such as asthma, being overweight, high blood pressure, heart problems etc., you must ensure you mention it to your adviser.
Additionally, higher incomes are often achieved by:
• Regular smokers
• Those who have retired from certain occupations
• Those who live in certain parts of the country
It is estimated that up to 40% of the UK population could boost their annuity income with an "enhanced annuity", if you think you fit that category, it's essential that you tell our team of annuity specialists about it. You'll stand a better chance of a higher income for the rest of your retirement.
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Annuities for Smokers
If you're a smoker, annuity providers factor in that you're likely to die sooner than the average non-smoker. They therefore assume that they'll not be paying you your annual income for as long. A presumed shorter lifespan means that being a smoker can increase the amount of income you receive from your annuity.As a smoker, you may already be entitled to receive a higher pension income, but also, dependent on your age, you may receive further enhanced rates of up to 30% above standard level annuity rates. For instance, if normally you would receive £1,000 per annum as a non-smoker, you might receive as much as £1,300 per year as an older smoker.
In the case of enhanced annuities it can actually pay to be older and in poor health!
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Unsecured Pension/Income Drawdown/Phased Retirement
You can choose an unsecured pension as an alternative to an immediate annuity purchase. Unsecured pensions are sometimes also known as income drawdown or phased retirement.With an unsecured pension, you can first take your tax-free cash element (it can't be taken later), and the balance would therefore remain in your selected pension fund. However, there is an exception to this in the case of phased drawdown, where your tax free cash and income requirements can be combined.
You can now draw down a chosen amount of between 0 and 100% of the calculated single person's annuity value for the remaining fund. The remainder can be converted into an annuity when you choose to end the arrangement. Unsecured pensions are definitely not a suitable option for all.
This type of plan is suitable for people who have a relatively large pension fund, usually over £100,000. It has a higher investment risk, as your investment includes equity based funds. This may be more suited to people wishing to defer taking their annuity, have another source of secure income such as a company pension, or wish to benefit from the greater flexibility and death benefits that this option provides.
The income levels available from the fund must be reviewed every 3 years to make sure they remain in line with HM Revenue and Customs limits.
In the event of the death of somebody in full drawdown, the spouse, partner or dependant would have a choice of doing the following with the remaining fund:
• Purchase a pension annuity using all of the remaining funds
• Continue with the unsecured pension/income drawdown arrangement using all of the remaining funds
• Taking the whole amount as tax free cash (subject to a 55% tax charge)
A potential advantage of deferring an annuity purchase by utilising income drawdown is that an annuity is based on your health at the time of purchase. Therefore if you were to suffer ill health during the drawdown period, you may then qualify for a higher annuity rate (an enhanced annuity) than you would have done when you entered the drawdown arrangement.
The disadvantage with income drawdown could be that if at the start you were drawing down the maximum income from the fund, you may have a lower amount left at the end (depending on growth) with which to purchase an annuity. You must also bear in mind that your pension fund may fall as well as rise.
There are two main types of Unsecured Pension
1) Capped Drawdown
2) Flexible Drawdown
Flexible Drawdown allows those with at least £20,000 per annum in guaranteed pension income to draw any level of income they require from their Drawdown fund. This may deplete the fund if high levels of income are taken, but does provide more flexibility, although it is important to remember that all of the income taken is subject to income tax.
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Phased Drawdown
Phased income drawdown allows you to draw an income from part of the fund leaving the rest intact to grow. You can take your tax free cash at intervals instead of all at once. If your remaining fund grows, it will mean that you could have a larger tax-free lump sum than taking it all in one go. This may be suitable for someone who is still working and paying tax or maybe somebody working part-time who does not necessarily need their maximum income.Phased income drawdown allows you to vary the amount of income that you receive from your pension. This gives you some flexibility if circumstances change. This also has an added advantage that part of your pension fund has the potential to carry on growing in a tax favoured environment.
It is essential that you obtain the appropriate level of advice before committing to this type of arrangement.
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With Profits Annuities
With profit annuities are an investment linked alternative to a guaranteed annuity.With profits annuities are unlike standard annuities where the fund is invested in gilts and the income level is guaranteed. The pension fund is invested in the with profits fund of the chosen pension provider. The future level of income is dependent on the investment performance of the chosen with profit fund. This means a with profit annuity can involve a higher level of risk than a standard annuity, and your income could fall or rise depending on future bonus levels.
There is more flexibility available under a with profit annuity arrangement when compared to a standard annuity. For example, you are able to adjust your future income levels within minimum and maximum parameters should your circumstances change. For instance, a 62 year old male may have a greater need for income from their own pension arrangements for the next 3 years until they start to receive the state pension. They could therefore set the income from a with profit annuity at a high level for that period, before reducing the income once they start to receive the state pension.
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Variable Annuities / Third Way Annuities
Although conventional annuities provide a guaranteed income, they're not flexible. You have to lock into current interest rates. Variable annuities offer a mixture of income and capital growth benefits.You will receive some income guarantees, but these provide less protection than the guarantees of conventional standard annuities.
Variable annuities can also provide you with investment growth potential. If you choose a conventional annuity you lock into the current gilt yields which under pins your guaranteed income, but with variable annuities it's possible to participate in any possible future growth.
Third way variable annuities aim to supply a level of secured income from an annuity whilst combining some of the flexibility of unsecured pensions (also known as income drawdown).
As these types of annuity product vary widely, it is important for you to ask a qualified annuity adviser for further information.
It is also important to ask the provider how strong the guarantee is if the company runs into financial trouble.
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The Argument Against Annuity Rate Tables and Calculators
You may already have visited other annuity sites and used an annuity rates calculator or consulted a rate table.• Were you sure that the information was in date?
• Did the table or calculator take into account all of the products on the market or was it just a selection?
• Did you know that specialist independent annuity brokers may have access to a wider range of retirement annuity possibilities?
• Was it an individual quote or just an illustration?
• Did the website promote particular providers over others as they were paid higher commissions by some companies?
• Are the annuity providers able to pay to list their products higher up the tables, or maybe have their products shown in a different way?
• Did you know that the annuity rates may change before your application actually goes through? If you received a quote, was it guaranteed?
Updated by machines or humans?
Did those sites use 'screen-scraping' technology that retrieves and transfers information from other programmes?According to Wikipedia, "Screen scraping is generally considered an ad-hoc, inelegant technique, often used only as a "last resort" when no other mechanism is available. Aside from the higher programming and processing overhead, output displays intended for human consumption often change structure frequently. Humans can cope with this easily, but computer programs will often crash or produce incorrect results."
But what if the site reassures you it is up to date?
Even if the annuity comparison table or calculator was 100% up to date and correct, were you aware that the stated rates may have no resemblance whatsoever to the income that you will actually achieve? This is because your annuity may increase due to circumstances as yet unknown to the site, i.e. your state of health, medication that you may be taking and whether you're a smoker or not. Some annuity providers even base your future income on your previous occupation or where you live.Again, let us say that you do eventually find a site where everything is up to date and works correctly; do you know at this stage whether you want a level, fixed-rate escalating or an rpi-linked escalating annuity? Also, have you considered your spouse's, partner's or dependant's percentage on your demise? Have you considered an unsecured pension? There are a bewildering array of choices.
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What does the FSA say about comparison sites?
Comparison sites have been heavily criticised in the media and by the Financial Services Authority (FSA) for their lack of independence and incomplete information. Consumers often do not realise that they are not getting the whole picture.The FSA say "Some may only include products that the website can make money from in some way, for example if you click through to the provider." They also state that you should never buy a product just on the basis of what you see on their own tables. They recommend getting advice before using their tables.
(Please note that the information on this page does not represent financial advice. You must consult a broker for complete information. "The argument against annuity rate tables and calculators" is an opinion only and you should not rely on this information to make (or refrain from making) any decisions.)
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Why use a pension annuity broker?
1. A broker may be able to secure a better annuity deal than you may be able to achieve.2. They're more likely to have access to a wider range of annuity possibilities than you.
3. Due to their ongoing relationships with annuity providers, they may be better placed than you to overcome any problems that may arise with your application.
4. You'll have a point of contact should anything go wrong or need prompt attention.
5. They work to a set of guidelines laid down by the Financial Services Authority (FSA) who regulate brokers' policies and working methods.
6. Annuity brokers have got an interest in recommending the correct product for your circumstances. They'll not wish to fall foul of stringent FSA regulations.
7. If you choose not to get FSA qualified broker advice, you may not be able to get compensation through the Financial Services Compensation Scheme if you have a future complaint about the recommended product.
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