Get set and go for retirement
Kelvin Martin, a 58-year-old retired stockbroker from Dagenham, wasn’t going to bother shopping around for an annuity. "It was only a small pension, so if it had been up to me I probably would have just taken the income the pension company offered me," he explains.
His wife, however, had other ideas. "She has the shopping gene, so she suggested we just take a look. She found a broker on the internet, and when we called we discovered they could get us 15-20% more income. I was really shocked."
Kelvin’s wife is firmly in the minority. Only a third of people shop around for their annuity, with the rest either daunted by the thought, lulled by inertia, or just uncertain where to start. However, as Kelvin’s experience shows, the rewards are worth the effort. The average increase to a typical pension is around 15%, and depending on your circumstances you could even double your money.
The process isn’t complex either. It simply requires you to work through your options, choose the type of annuity that suits you and approach either a broker or a handful of insurance companies.
Before you can start hunting for annuities, you need to make a few decisions.
The first question is whether you want a guaranteed level of income, or whether you’re happy to accept some risk.
"You can opt for guaranteed or investment-linked annuities," explains Stuart Bayliss, director of adviser Annuity Direct. "If you are happy to take some investment risk in the hope of potentially boosting your income, you can then choose between with-profits or unit-linked annuities. With-profits contain some level of guarantees that your income won’t fall below a particular level, but if the investments go awry both could leave you with less to live on. That’s why most people opt for a guaranteed annuity."
The second question is whether you want your income to rise with the cost of living. Nigel Callaghan, a pensions analyst at IFA Hargreaves Lansdown, explains: "Your annuity income can be set to rise with inflation, in the form of the Retail Prices Index, or by a certain percentage each year. Obviously it’s a good idea because otherwise the effect of inflation is pretty severe."
As Bayliss points out: "Even if inflation is 2.5%, over 20 years you’re losing half the buying power of your money."
However, this comes at a cost, and your starting income could be considerably lower. "A 65-year-old man with a fund of £100,000 will get a rate of return of 7.6% with a level annuity," says Peter Magliocco, associate regional director of the Annuity Bureau. "If you add in a link to RPI you’ll get around 5%. That’s an impact of around £2,000 on your starting income."
You also need to decide if you want any guarantees. If you buy a five-year guarantee, for example, the insurance company would pay five years worth of annuity income to your estate if you die the following day.
Again, this would affect the level of income, but because they guarantee a certain value for money they are a popular option.
After that, you need to consider whether you want a spouse pension, which would ensure that your partner received some a pension even after your death. They are particularly suitable for couples where one partner has no pension. But, like all good things, these come at a cost, so should be considered carefully as part of the household’s pension provision.
Once you know which bells and whistles you want, you need to consider your health. If it isn't good and your life expectancy is lower than a healthy person, you could get a higher income with an enhanced or impaired life annuity. Prices are based on your individual circumstances.
"If you have had certain illnesses or make lifestyle choices such as smoking you are statistically likely to live for a shorter period," says Callaghan. "Enhanced annuities recognise that fact and will pay a bigger pension."
This is worth considering, even if you don’t feel particularly ill. Owen Wintersgill, a director of the Annuity Discount Brokerage, points out. "The impaired life market has changed. You used to have to be seriously ill, but now you can qualify for one on very mild grounds such as high blood pressure, high cholesterol or being overweight," he says.
An estimated 40% of people should be buying an enhanced annuity, and it can make a huge difference to your income. Peter Magliocco says: "One client was recently able to get an increase of 28% just on the basis that he was a smoker."
Beyond your health, you can also consider a policy priced according to your postcode. "With increases in technology it is possible to look at the postcode and give a price that’s pertinent to the individual," Nigel Callaghan explains. "If you live in leafy Kensington, for example, you are more likely to have had a good diet and no manual job, so you are statistically likely to live a lot longer than someone living in a less nice suburb of Glasgow."
At the moment, Legal & General is alone in providing annuities priced solely on postcode, but as it can make a 5% difference to your quote it’s worth considering.
Similarly, the trend towards individual pricing is accelerating, so if you’re statistically likely to live for less time you should benefit from this sort of pricing.
However, if you’re healthy and wealthy you might have to consider an alternative strategy.
One option is to put off buying an annuity for a few years. This you can do through income drawdown or the use of temporary annuities.
Simply putting it the decision off in the hope that annuity rates will improve is a no-go, warns Bayliss. "Between the years 2000 and 2005 the cost of delaying the decision was enormous, so putting off buying a pension would have cost you dear. The cost of delay for the last four years has been nothing, because rates are the same as they were four years ago and funds are higher, but the outlook is uncertain."
The current situation has been brought about partly through furious competition. Added to this, the way annuities are priced means they have been helped by the current crisis in corporate bonds, the yield from which is crucial in the pricing of annuities.
Callaghan explains: "The corporate bond market is 50% financials, such as banks, which have been adversely affected by the credit crunch. The value of these bonds has gone through the floor, so the yield has gone up."
However, the prevailing trend in annuity rates remains downwards, says Magliocco. "Rate improvements in the long term are unlikely because life expectancy statistics show an ongoing improvement."
However, it may be worth putting off getting an annuity altogether on the chance that your health will deteriorate and you will be entitled to an enhanced annuity, suggests Callaghan. "It’s increasingly common, and a pretty good idea. When someone wants to take an income they do so initially via income drawdown, with the intention that 10 years down the line they are going to buy an annuity. They are doing it because the chances of contracting an illness that would entitle you to an enhanced annuity become higher."
But this is a calculated risk and a very personal choice to make - only you know your family history, lifestyle, and current state of heath, and only you will know if you are happy taking this kind of chance.
One issue is that after the age of 75, the rules on income drawdown become far less attractive, so most people annuitize by then. However, while the chances of you becoming ill before then may be high, this is far from guaranteed, according to the Office for National Statistics. It found that the average woman will live disability-free until 75.7 years old, while the average man will be disability-free until four months shy of his 75th birthday, so it’s worth factoring this into your decision.
There are, clearly, lots of options to weigh up. That doesn’t mean you have to be tempted by any of them, and an estimated 85% of people choose a straightforward single life level annuity. But it’s worth getting to grips with the market and shopping around to ensure you get a good deal.
This is likely to be particularly paramount in years to come, reckons Callaghan. "Last year £12 billon was invested in annuities and income drawdown. In four years that’s predicted to be £18 billion. The at-retirement market will soar because of the baby boomer generation and the demise of final salary schemes."
So annuities will be more competitive than ever, and you stand to lose out even more if you simply take what’s on offer from your pension provider.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
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.
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).
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
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.
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.