Annuity Guide

What is an annuity?
 Single or Joint annuities 
 Level annuities 
 Escalating annuities
 Enhanced annuities
 Guaranteed Period annuity
 With profits annuities
 Present annuity rates
 Unsecured pensions
 Alternatively secured pensions (ASPs)
 Limited period annuities and value protected annuities
 Summary


Annuities are the vehicles, which for most of us turn, the pension pot we have built up over the years into an income for our retirement. At present, when you wish to take you pension, in most cases you have to use 75% of it to purchase an annuity before you are 75 years old, and can take up to 25% of the remainder as a tax free lump sum.

What is an annuity?	Top

An annuity is a type of investment offered by an insurance company that guarantees to pay an income for life, regardless of how long you live. There are two types of annuities:

• pension annuities
• life annuities

Pension annuities are purchased with the pension pot that you have built up during your working years, at present this is how most people obtain an income from their pension pot, and after you have taken out the 25% tax free lump you are entitled to, purchase of the annuity is compulsory.
 
Life annuities, on the other hand are voluntary and there are a number of types of life annuities on the market to suit most individual needs. Both types of annuities work in the same way.
The insurance company that provides the annuity is working on the surety that one day we all will die.
Because we are not all programmed to die at the same time, some of us will live longer than others and the insurance companies know this. They also know the average life expectancy of men and women living in the UK, so they can work out the rates that the annuity will return in exchange for your pension pot.
To put it simply, those of us who die early, pay for those of us who live longer.


Now the burning question is “How much of an income will I get from the annuity in return for my pension pot?” Good question!
 
Well, the overriding factor of how much you will get as an income depends on how much you have in your pension pot, as the more you put into an annuity the more income you get out. But as with all things, it is not quite as simple as that. The amount of income you receive will also depend on a number of factors such as, hold old you are, what sex you are, as on average women live longer than men. It also depends on what type of annuity you purchase with your pension pot.

This type of annuity takes into account inflation so therefore the income that the annuity pays out increases according to the retail price index (RPI). However if you go for an escalating annuity, you will have a lower income to start with.

Annuity rates are a lot lower than they were in the past, in the last twenty years annuity rates have approximately halved. At the present a male aged 65 with a pension pot of 100.000 GBP would receive a level single life pension with no guarantee of 7,700 GBP gross per year.

An unsecured pension is an alternative to buying an annuity. It allows the customer to draw an income from their pension fund while leaving their fund invested. A customer under 75 can take out an unsecured pension and either draw an income by using income withdrawal (also known as pension fund withdrawal or pension drawdown), or by using a 'short-term annuity'. An unsecured pension will stop at age 75. By that time, customers must secure an income from their pension funds, which generally means buying a lifetime annuity, or an Alternatively Secured Pension.

Advantages of Unsecured pensions are:

• The tax-free lump sum can be taken
• The income can be varied between an upper limit and no income (the upper limit is set by the government
• Avoid buying an annuity
• Don’t have to decide on whether to include spouse’s benefits on an annuity
• The fund remains invested in a favourable tax environment
• As the fund is still invested it could grow further

Disadvantages of Unsecured pensions are:

• Annuity rates may fall
• The fund value may fall
• The income is not guaranteed
• Ongoing monitoring of the plan
• Charges higher than annuity purchase
• Loss of the cross subsidy gained through annuity purchase

Alternatively secured pensions (ASPs) were introduced from 6 April 2006.

Rather than you being forced to buy an annuity at age 75, ASPs offer you greater choice and flexibility if you want to keep taking an income directly from your pension fund. It isn't suitable for everybody. When you die, your pension fund can only be used to provide income for your dependants, or be paid as a lump sum to a registered charity. There may be an Inheritance Tax charge on the fund remaining at your death.

The good thing about ASPs is that you can avoid buying an annuity, and control when you take your income and how much - within Government limits set by the Government Actuary's Department (GAD). You must take at least 55% of the yearly pension that GAD decides someone in good health could get from an annuity bought on the open market, and you can take a maximum of 90% of that amount. Any shortfall will be liable to a 40% tax charge, which is levied on the plan.

You can use ASPs simply to put off buying an annuity rather than deciding against buying one completely.

Since the government’s pension reforms of April 2006 you can purchase two new types of annuity, the ‘limited period annuity’, and the value-protected annuities’. A limited period annuity lasts for a five years, after which you have the choice to buy another ‘limited period annuity’ or go for a normal annuity. With a value protected annuity, when you die the value-protected annuity will pay out any unused amount within the value-protected annuity to your dependents. However, this comes at the price of accepting a lower pension income than you would have received from a normal annuity.

Love them or hate them, pension annuities have been around for a long time, and look set to be around for a little longer. You have been building up your pension fund throughout your adult life and the government has been assisting you in this by allowing you to build up your pension fund tax free. Now it’s payback time and the government wants it’s money back. It achieves this by taxing the pension income you receive from your annuity. Now rather than watch you blowing your pension fund on holidays, gambling, and so on, after which, you throw yourself on the mercy of the state, the government makes you responsible for your own future by making you buy an annuity with most of your pension fund so that you won’t starve in your old age. Because an annuity gets you a pension income that will last you for your lifetime whatever that will be, hopefully a very long time, and when you die the pension income stops. Nothing left to pass on to your descendents, end of you, end of the annuity. Now, how does the insurance company make sure that they have enough money to pay out guaranteed pensions incomes for as long as you live? By investing your pension pot in some very very safe investments, in fact they invest in government bonds otherwise known as gilts. Although being a very safe investment, gilts do not exactly set the world on fire when it comes to dazzling returns. It was OK to invest your pension pot in gilts when we only lasted for a few years after we retired, but now we are all living a lot longer and therefore need our pensionable income to last a long time as well. The time will come when there will have to be a viable alternative investment to annuities as to where to put our pension pot that gives us a better rate of return. Until that time comes, if you are in the market for an annuity, make sure you choose the right one for you, because once you have bought it, there is no going back, you are stuck with it, so make sure you get it right first time. Always shop around for the best deals, as rates will vary from insurance company to insurance company.