Avoid being short-changed in your retirement
Annuities - policies that produce an income from your pension - have hit the headlines recently for all the wrong reasons.
"Pensioners are being 'burgled' by insurers on annuities," claimed the Daily Telegraph, while the Daily Mail went a step further, saying: "Elderly savers being fleeced by pension sharks when they retire."
The source of all this outrage is a report by the Financial Services Consumer Panel, which concludes pensioners are being charged thousands of pounds in fees by insurers, brokers and financial advisers when they convert their pensions into an income for the rest of their life.
The report says the insurance industry is making excessive profit from annuities, with some insurers making up to 20 times more profit on an annuity than on other products sold by their business.
It is, adds the report, impossible for pensioners to know if they are getting a good deal.
You only buy an annuity once, and the average pension used to buy an annuity is small – about £27,000. But this makes understanding how the product works all the more important.
How annuities work
An annuity is an insurance contract that provides you with an income for the rest of your life in return for your pension savings.
In most cases, once you have bought an annuity and handed your money over to the insurance company, that's it. The company is committed to paying you an agreed income regardless of how long you live. Once sold, the terms cannot be changed and even if you die soon after buying the annuity, none of the money will be returned to your estate.
How much income you receive will depend on a number of factors including interest rates and gilt yields at the time of purchase, your age and health, and the type of annuity you are buying.
Up to now, the vast majority of people have bought annuities from the company that they have invested their pension with over the years.
How much will you get?
But the annuity rates set by insurers vary widely. Someone aged 65 years buying an annuity in September 2013 with £27,000 from their pension savings could get between £1,300 and £2,000 a year, depending on their circumstances and the provider they chose.
Unless you have been lucky enough to invest with the insurer that offers the highest annuity rate at the time when you retire, staying loyal could mean you lose out quite drastically.
The Association of British Insurers publishes example rates for nearly all annuity providers, which will give you an idea of the wide range of payments (abi.org.uk/Insurance-and-savings/Products/Pensions/Annuity-rates/Example-rates).
These are only examples, so it's vital to shop around to get the best rate possible before signing your savings away.
You should also check on what basis you are being sold your annuity – with or without advice. Although the former might sound more expensive – and you do have to pay for it out of your pocket – the non-advisory route enables the insurer or broker to take commission from your pension pot. This can prove a lot more expensive, with brokers being offered up to 4% of your pension to make the sale.
Non-advice brokers also usually offer annuities from a panel of insurers, so you might not get the best possible rate for your circumstances.
If you take advice, you will be given help in deciding what type of annuity you need – such as one that pays out a flat rate of income or increases in line with inflation, or that pays out an income to your partner after your death. All these factors will have an impact on the money you can expect – with the flat rate, no-payments-after-death annuity paying out the highest level of income from the outset.
Your age and health
The older you are when buying an annuity, the higher the income you will get. The insurer is calculating it will have fewer years to pay out before you die, so it can afford to be more generous.
However, that does not mean it is necessarily a good idea to defer buying an annuity. Bob Bullivant, chief executive of Annuity Direct, says: "If you defer taking an annuity for a long time, you've got to do something with your fund which will probably involve moving it off deposit and into equities. You're putting the fund at risk, which takes some very careful thinking about – you are at the mercy of the markets.
"You also need to think about the lost cash flow. If you defer for two years, say, when you eventually take your income you need to get an even bigger income to recoup the lost money, which could take up to
Your state of health can also have a big influence on the income you get. If you suffer a life-shortening condition, such as high blood pressure, or you smoke or are very overweight, you could be eligible for an enhanced annuity. Put crudely, this pays you more money – up to 50% more in some cases – because you are not expected to live as long as someone of the same age in good health.
Insurers generate the income they need to pay out to you by investing in corporate bonds and gilts. The yields on these type of investments are affected by interest rates on savings – if savings rates are high, corporate bonds and gilts will be less popular, their price will fall and the yields go up so you get a higher annuity rate. Unfortunately for anyone buying an annuity in the past few years, the base interest rate has been kept at 0.5% as the Bank of England has struggled to control inflation.
The situation has been compounded by quantitative easing – the Bank of England's buying-up of bonds – which pushes up the value of bonds and gilts.
So when it's time for you to look at what to do with your pension, remember to look at all the factors that could influence your annuity– whether it's your own health or the health of the economy.
The best and worst annuity rates
Taking a non-smoking, healthy woman born in 1952 as a guide, we used Annuity Direct to search for the best level annuity quotes, based on converting a total fund of £100,000, minus a £25,000 lump sum.
The annual quotes identified were:
|LEGAL & GENERAL||£4,252.12|
The difference between the best (L&G) and the worst (Standard Life) was a whopping £573 a year.
With a guaranteed period of 10 years added, the difference between the best annuity quote (again, L&G at £4,107.12) and worst (again, Standard Life, at £3,556.80) was £550 a year.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Association of British Insurers
Established in 1985, the ABI is the trade body for UK insurance companies. It has more than 400 member companies that provide around 90% of domestic insurance services sold in the UK. The ABI speaks out on issues of common interest and acts as an advocate for high standards of customer service in the insurance industry. The ABI is funded by the subscriptions of member companies.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.