Do you know your pension fact from pension fiction?
Fiction: If I buy an annuity, all my money will go back to the insurer when I die.
Fact: This only happens if there are any funds left when you die and you don’t buy a guarantee to ensure payments are made for a fixed period of time.
According to the Association of British Insurers, 51% of all annuities are sold with a guarantee, while Retirement Advantage says its figures show 80% of advised customers buy a guarantee. Prior to the rule changes in April 2015, guarantees were capped at 10 years but they are now available up to 30.
Fiction: Income drawdown will give me a better income than an annuity.
Fact: Income drawdown allows you to choose how much income to take, so while you can take a higher income than would be achievable with an annuity, you are likely to eat into your capital and you may end up running out of money. With an annuity, your income is guaranteed, however long you live.
Fiction: My money is better off in my hands.
Fact: Just because you can take money out of your pension savings, it doesn’t mean you should. When you take money out of your pension, you could be stung with a hefty tax bill and lose valuable protection from income and inheritance tax.
This is particularly important if you don’t have a purpose for your money other than putting it in a savings account or investment fund, as these options are still available to you within your pension.
Fiction: I should buy my annuity from my pension provider.
Fact: No! Your ‘open market option’ allows you to shop around for the best deal, just as you do with your car insurance and savings accounts. This could boost your income by a typical 17%, according to the Financial Conduct Authority.
Fiction: I need to keep my health problems and vices under my hat.
Fact: Health problems may mean you pay more for life insurance, but those in poor health will get a better deal on annuities. This is because less healthy people are likely to have a lower life expectancy, so underwriters can pay a higher income. Specialist providers may also boost your income if you smoke, are overweight or have high blood pressure.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
Open market option
People who have a money purchase or defined contribution pension, at retirement must use their fund (minus an optional 25% as tax-free cash) to purchase an annuity. As the annuity market is very competitive and rates differ vastly between annuity providers on a daily basis, the open market option is your right to shop around and buy the annuity from the company offering the highest rates at that time.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
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.