Six steps to choosing the right annuity
After years of mis-selling and misbuying, a glorious brave new world for annuities has arrived. We should all rejoice and get the flags out because purchasers of pension annuities will no longer be fleeced.
Since the beginning of March, a majority of people turning a lifetime of pension saving (made through a defined contribution or money purchase pension scheme) into an annuity – a stream of annual income – can be rest assured that they will end up with an annuity or an alternative generator of regular income that will help see them through a financially comfortable retirement. No longer will they be sold an annuity pup.
This brave new world for pension annuities is a result of the introduction of a new code of conduct by the Association of British Insurers (ABI).
In a nutshell, it requires all providers of pension funds (that belong to the ABI) to give retirees all the information necessary to make a correct annuity purchase. Scandalously, this didn't happen pre-March, leading to widespread consumer detriment.
But rather than just relying on the code to defend your retirement interests (and not all pensions are covered by the code), how do you go about ensuring you make a 'correct' decision over the use of the proceeds from the pension fund you have painstakingly contributed to during your working life?
Here are six crucial steps you need to take.
Step one: check your pension policy documents for all-important guarantees. Some pension policies bought in the 1970s and 1980s contain the right to the purchase of so-called guaranteed annuity rates (GARs) at retirement.
These GARs were offered at a time when interest rates were much higher, with the result that they deliver a higher level of income than any annuity offered today. If your policy contains such a GAR, snap it up.
Often, these GARs are only available for a restricted time (for example, on your 60th birthday), so it's best to find out about their existence ahead of your retirement.
Step two: when you buy an annuity, ensure it protects your family. If you purchase a single life annuity, it dies with you, which can cause acute financial pain for the remaining spouse. Yet annuities can be bought that offer a reduced spouse's pension – typically half – in
the event of the policyholder's death.
Step three: if you've smoked or had a history of poor health, declare it. An annuity is one area of personal finance where a history of health issues or a smoking habit (past or present) can get you a better deal.
This is because annuity providers will pay you an enhanced rate in acknowledgement of your below-average life expectancy. So disclosing all the gory details will help provide you with a higher income.
Step four: shop around. Shopping around for an annuity should ensure you get an annuity between 15 and 20% higher than the one that your pension fund provider will offer you. It's an easy thing to do and there are annuity specialists galore out there who will help you in this process. Among the most established are The Annuity Bureau, Annuity Direct and Better Retirement Group.
Step five: think alternatives. You don't have to buy a lifetime annuity with your pension fund when you retire.
You can hold off buying an annuity and instead keep your pension fund invested while drawing an income from it. These arrangements, called income drawdown plans, have proved increasingly popular over the years. But they are not without risk and there are strict controls governing how much income you can take. If you are considering such a scheme, take independent financial advice.
Another alternative is a temporary or short-term annuity. These allow you to lock into an annuity rate for an agreed period (typically five years) in the hope that afterwards you can use your pension fund to buy a lifetime annuity on more favourable terms. Annuity rates are
currently at rock bottom so delaying could prove advantageous.
Step six: turning your pension fund into lifetime income is too important a financial transaction to get wrong. Seek advice. It will be worth its weight in gold.
Jeff Prestridge is personal finance editor of Financial Mail on Sunday. Email him at email@example.com
Money purchase pension
A pension plan where the level of benefit paid out in retirement is solely dependent on the accumulated value of the contributions. It’s another term for a defined contribution pension.
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
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.
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.