You can now spend your pension as you wish, but with 43% of 50- to 65-year-olds planning on buying an annuity*, a significant number of retirees still want a guaranteed income.
For many people, the best way to buy that security is with an annuity. Here’s our 10-step guide to picking the right one.
1. Talk to your current provider
Contact your pension provider to get an up-to-date annuity quote first. You’ll usually be able to get a better deal elsewhere. However, if you bought your pension during the 1970s or 1980s, you may have a ‘GAR’ or guaranteed annuity rate that you’ll be unlikely to match on the open market. The catch is you may have start taking benefits on a specified date and may not be able to arrange additional benefits such as guaranteed payments after you die. If you don’t have a GAR, you at least now have a starting point for your own research.
2. Shop around
The difference between the best and worst payouts is around 7%*, so it’s essential you exercise your ‘open market option’ – this is your right to ditch your pension provider and shop around. You might not think the difference sounds much, but over a 20-year retirement it could rack up to £7,133 in lost income for somebody with a £100,000 annuity.
Unfortunately, most of us don’t bother to shop around. In fact, an astonishing 60% of people accept the annuity offered by their pension provider, according to the Financial Conduct Authority (FCA).
The FCA has announced new rules that will force annuity firms to tell people how much better off they would be if they shopped around from March this year. In addition to telling you what income they will pay you, they will also have to tell you what the best available rate on the open market is.
It won’t tell you which provider is supplying that rate or take details of your health into account, so it’s a nudge to encourage you to do your own research, rather than a replacement of it.
Shopping around is easy with comparison websites. After answering a series of questions, the site will come up with a list of the top-paying providers. Check a few sites as not all will include every provider. A good starting point is the service offered by the Money Advice Service at Themoneyadviceservice.org.uk.
3. Decide how long you want to annuitise for
Lifetime annuities pay out until you die. However, if you aren’t happy tying up your money for life, you could opt for a fixed-term annuity.
“You choose the term and the final sum you want repaid to you and then we work back from there to work out what income we can offer you,” explains Vanessa Owen, head of annuities at LV=. Fixed-term annuities, however, are not available from every annuity provider.
4. Admit to any vices or health problems
Shopping around will massively increase your annuity income, but it isn’t the end of the road. The vast majority of retirees could also increase their income by getting an enhanced annuity. Enhanced annuities pay more to individuals with medical problems or habits that give them a shorter life expectancy.
Admit to all your vices and health problems, and you could significantly increase your retirement income. A 65-yearold smoker with high blood pressure and high cholesterol and a £45,000 fund would get £3,091.68 a year, almost 37% more than they would get with a standard annuity, while someone with a serious impairment could almost double their income*.
As many as 75% of retirees could be eligible for enhanced rates, but don’t take up smoking now just to get a better rate. You need to have been smoking long enough for it to seriously impair your life expectancy in order for it to boost your annuity income.
5. Think about your dependants
Before you buy your annuity, think about anyone that relies on you for money. Once you have died, how will they pay the bills? Joint-life annuities ensure your income won’t stop until you’ve both passed away. You can opt for 100% of income to be paid, or select a lower proportion such as half or two-thirds.
Joint-life annuities pay a lower level of income than single-life annuities, but failure to protect a spouse could leave them impoverished if they don’t have another income once you’re gone.
6. Do you want to protect your money?
When you die, annuity payments stop. This means if you die early on in your contract, huge sums of money may go straight back to your insurer. If you are concerned about not getting value for money, you can plump for guarantees. These ensure payments will be made for a fixed period, irrespective of when you die. These can stretch for as long as 30 years. Alternatively, you can choose value protection, which returns any remaining funds when you die. Again, both these options will reduce the income you receive, but provide valuable peace of mind (see box above).
7. Think about inflation
Often called the ‘silent thief’, inflation’s ability to reduce the spending power of your money should not be underestimated.
Looking back over the past 30 years, the cost of goods and services has risen by 166% according to Office for National Statistics data. To put that into perspective, you’ll now need around £2,659 to replicate the spending power of £1,000 in December 1987. For this reason, you can choose an income that increases in line with inflation. However, this will reduce the initial income you receive and so you may have to live a very long time to get value for money.
Figures from JLT Pension Decision show that at the time of writing the best level annuity for a healthy 65-year-old with a £50,000 pot was £2,812 a year. However, with inflation protection that income dropped to a starting rate of £1,751.
Just how important inflation protection is for you will depend on how much of your total income your annuity accounts for. If you have other money invested or in an income drawdown plan, that should provide you with some hedge against inflation, making it less important than those retirees who are more reliant on their annuity. Final salary pension payments will also increase in line with inflation, as will your state pension.
8. Double-check your rate
Once you have found the insurer that will pay the highest income, structured in the way that you require, you’re ready to apply. However, if during the application process, you have made any changes, it is important to go back to the market. With a different set of requirements, you may find another insurer will offer a better income.
9. Be certain of your choice
After an initial cooling-off period, in which you can cancel your contract, your annuity will become irrevocable and you will not be able to change or switch your plan. Given that you will probably be handing over a sizeable chunk of your retirement savings, make sure you completely understand the annuity you have chosen, and are certain it is the best product for you.
10. Don’t discredit advice
Buying an annuity is a major decision that will affect your income and financial security for the rest of your life. There are few times in life where it is more important to get professional advice. It may seem pricey, but if an independent financial adviser can help you increase your retirement income it could be worthwhile over the longer term.
You can get a good deal online, but don’t assume it’s free. Annuity brokers take a commission that reduces the income you’ll receive. This could be around 1.5% to 2.5% on a standard annuity, rising to 5% for enhanced annuities, according to the FCA. You can often get advice for a similar sum with the benefit of consumer protection in case you are missold an annuity