How do I choose the right annuity?
When you reach pensionable age and can access your pension pot, there are lots of options to choose from when it comes down to deciding what to do with your money. One of the most popular of these is an annuity, which gives you a regular income throughout your retirement.
But choosing between annuities can be tricky. When you buy one, the decision is usually irreversible, meaning if you make the wrong decision you could feel the effects forever. That’s why we always recommend you enlist a skilled and objective financial adviser to help you choose the right annuity for you.
To give you some initial guidance, here's an introduction to the world of annuities.
One of the most important things to look out for is the annuity rate. This is the amount of money you will be offered each week, month or year, compared to the amount of money the annuity is bought with. Higher rates mean that the money will be paid out in larger instalments, while smaller rates mean you'll have to live longer in order to receive back all of your money.
The rate you receive is dependent on more than just your age at purchase.
- Your life expectancy (based on UK-wide population trends).
- Your health (with higher yearly incomes paid to those with health problems or bad health habits such as smoking).
- The amount of money you invest (used to buy the annuity).
- The state of the economy (interest rates, bond yields and so on).
- The variety of annuity you choose (and if you have added extras on to it).
Common annuity options
There are lots of annuities your financial adviser will tell you about. The one you choose will depend on your own circumstances and plans for the future.
Common among pensioners, lifetime annuities give the annuitant (the person receiving the annuity) an income until they pass away. The money paid is used to purchase low-risk investments, which grow the pot and cover the costs of the provider. Lifetime annuities can be for a single person, or can cover two people, still paying out to the survivor after one passes away. There are various types of lifetime annuities, some of which are detailed below. The amount of money you receive can depend on a whole host of things, from where you live to the type of job you had.
Enhanced or impaired life annuities
If you have a medical condition, are overweight, a smoker, have worked in a dangerous working environment, or have been affected by other factors that could shorten your lifespan, then you may be able to receive an enhanced or impaired life annuity. These will give you a better annuity rate (i.e. more money more quickly) than the norm, given the higher probability that you might die early. These are classed as lifetime annuities.
Again, this is a lifetime annuity, where you money is invested in the stock market and other financial investments. You will receive a base income, which will rise if your investments perform well, or fall if they do badly.
This form of annuity is much like a lifetime annuity, except the number of years the annuity is paid out is fixed (or until you die). The maximum period for a temporary annuity is five years – useful if you only want to commit a portion of your pension pot and don't want to commit to a lifetime option.
Purchased life annuities
If you have money that isn't in your pension pot – ISAs, for example – then you can use this cash to buy a purchased life annuity. The income you receive can either be for a fixed period or for the rest of your life.
When you get an annuity, you will be able to choose from a range of options regarding how payments are made to you.
You can choose a level annuity if you'd like to receive the same income level for the entire period of the annuity, however, this can mean the payments are worth less in the future, due to increases in the cost of living or inflation.
Then there's an increasing annuity, which protects you against rising inflation and cost of living, meaning the overall worth of the annuity stays the same for the entire period. However, for the first few years your income may be lower than what you might receive from a level annuity.
You can also choose a value-protected annuity, which ensures that when you die, the unpaid income is paid out to your loved ones. These can cost more money, however.
A guarantee period means your income is paid for a guaranteed length of time, even if you die before the guarantee period ends. So, for example, if you choose to guarantee your annuity income for ten years but die three years after, the annuity payments will continue to beneficiary for the remaining seven years. If you die before age 75 the income payments will be made to beneficiary(s) tax-free until the end of the guarantee period. If you die from age 75 onwards the income payments made to beneficiary(s) will be taxed at their marginal rate.
There are a lot of options to choose from when it comes to picking an annuity, but by understanding exactly what's on offer, you can pick the right one for you, securing your future in the process.
You can also choose to buy an annuity within a tax-advantaged wrapper, such as The Retirement Account. This could give you additional benefits when compared with a standalone annuity, for example more flexibility of how and when you take an income, control of income tax, and potentially saving tax for beneficiaries on your death.
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