You can find a lot of information online regarding annuities; however, many people are still unsure what an annuity is.
If you have a pension, the choice of whether to purchase an annuity or not can be a big decision to make, and many pension companies can sometimes push members to purchase an annuity – but what exactly is it?
When you start withdrawing your pension, you need to turn it into an income first.
An annuity will be a percentage of your total pension pot.
An annuity is a financial product that you can purchase from an insurance company. Once an annuity is purchased, your annuity will provide you with a regular set income for the remainder of your lifetime.
For example, if you’ are offered an annuity rate of 5% and you have a pension pot worth £600,000, you will receive £30,000 per annum as an income for the remainder of your lifetime.
Many people believe that a pension automatically supplies you with an income during your retirement, this is not strictly true. Your pension, which you have contributed to for many years, is hypothetically a pot of money.
Upon retirement, you can decide to use the pot of money to purchase an annuity to supply you with a set income during your retirement. You can buy an annuity from your existing pension provider as a way of taking your retirement income.
An annuity is just one option for retirement income; there are many other options and various types of annuities.
You are eligible to purchase an annuity if you have a personal pension or defined contribution pension. With other types of pensions, such as a defined benefit pension, your income can be paid directly to you, so you don’t need to purchase an annuity.
For UK expatriates with a QROPS or QNUPS, it may still be possible to purchase an annuity; however, this is not required in most scenarios as you can normally draw your income directly from the scheme.
It is important to note that annuities are not applicable for state pensions.
Insurers sell annuities to offer a fixed income for the remainder of your lifetime. Annuities are not required by law, so in some ways, purchasing an annuity can be seen as a risk. Once an annuity is purchased, there is no flexibility to change your mind afterward.
When purchasing an annuity, it is vital to seek independent advice to ensure you have explored and fully understood all of your options.
An annuity can be purchased during the six months before retirement. During this period, you will receive information from your existing pension provider on the value of your pension and the available annuity options.
The information offered should include the importance of exploring your options with annuities and shopping around. The FCA released a report in 2014 highlighting that pension providers were not communicating the importance of shopping around and were unaware that there were other options out there than what was being offered.
You will be asked numerous questions before you get to choose your annuity; similar to when applying for health insurance, these questions will give the annuity provider information about your lifestyle to allow them to estimate your expected remaining life span.
The main benefit of purchasing an annuity is that once purchased; it provides you with a guaranteed income for life. Once you have the amount set, you can plan the remainder of your life based on the guaranteed income provided.
If you choose the annuity wisely, you can avoid the chance of being affected by inflation as the income you receive will rise with inflation, therefore ensuring that rises in the cost of living are met.
If you have ongoing health issues, you may also benefit from an annuity as an insurer will offer a higher annuity rate due to your lower life expectancy. The rate offered can be as much as 65% more.
On the other hand, if you live longer than your life expectancy, you may find that your total income is greater than your actual pension pot.
Once an annuity is purchased, you cannot change your mind; the income for the remainder of your lifetime is set and will not change.
Annuity rates, like interest rates, fluctuate constantly and are not solely based on your unique personal situation. Like with a mortgage, you have a window of time to make your decision, and if the economic situation is not secure, you could be offered a lower annuity rate than if you retired at a different time.
There is another drawback with annuities; you cannot leave anything behind for your family or loved ones. Therefore, if you die before you’ve received your full pension, the rest of your pension pot stays with the insurer.
The above drawbacks are why emphasis is placed on shopping around and seeking reliable financial advice.
You can still purchase an annuity if you wish; however, there are various other options available for you which can make an annuity unnecessary.
The most considerable risk with annuities is being unaware of all your options. Your pension provider will be very keen to sell you annuities through them and will therefore make them seem as attractive as possible.
As emphasized, you should always seek independent and impartial advice to ensure that all of your options have been explored before making a final decision, as this cannot be reversed.
If you are currently an ex-pat, there are many alternative options for you alongside annuities.
Our initial consultations are always free, so there are no risks involved with exploring your options for peace of mind, especially when deciding on the income for the remainder of your lifetime.
