If you have been putting money aside into an occupational or personal pension, the process after you retire is not as simple as simply withdrawing money. An annuity is a financial option which allows you to convert your pension into retirement income that will last you for the rest of your life. There are advantages and disadvantages of this option. You can only buy an annuity if you have a defined contribution (DC) or a personal pension. Defined benefit or final salary pensions pay you an income directly so an annuity is not necessary.
When you get your annuity quote, you will be given a percentage. You multiply this by your total pension fund to discover your annual income. For example, if you have £100,000 in your pension savings and an annuity rate of 7%, you will receive £7,000 per year.
In the 2014 budget, the Government announced a number of changes to pensions. The most significant of which is that from April 2015 onwards, people will be able to access their private pensions as they wish from the point of retirement and will not have to arrange an annuity. There are also a number of proposed changes to tax rule to allow annuities to become more flexible. This includes the following:
1. Instead of the current fixed rate, annuity providers will be able to vary the amount of income paid out. This will allow people to (for example) take less money at the start when you first retire and more later on to account for care in your later years.
2. You will be allowed to withdraw a lump sum from an annuity. The current annuity system pays yearly without any option for further withdrawals. This new rule will give you the option when you buy to be able to withdraw a lump sum.
3. Currently, guaranteed annuities pay out to your family once you have passed away, but this usually only lasts up to ten years. From April next year, the Government will ensure that your pension fund is returned to your family after you pass.
Advantages of Annuities
1. Guaranteed Regular Income
Perhaps the greatest benefit of an annuity is that you will have a reliable income source guaranteed each month. It is low risk and will not be subject to stock market fluctuations as other investments are (unless you buy an investment-linked annuity).
2. Account for Inflation
As prices rise each year due to inflation, the value of your income this year is not the same as next year. There are annuity options which will increase in value each year to account for this inflation. This will help you when planning your budget to help you to live a comfortable retired life.
3. Increase for Care Requirements
There are annuity options available which will pay out a higher income than standard annuities if you become unwell and require health care. This can result in an increase of up to 65%.
Disadvantages of Annuities
1. Decision is Irreversible
Buying an annuity is a life decision so it’s important to make the right choice. Once you have signed up for an annuity and have started receiving income from it, you can’t change your mind or change providers for a better deal like you can with other savings options. From April 2015, you will not be obliged to buy an annuity.
2. No Family Support
If you have invested all of your pension savings into you annuity, the agreement lasts until you pass away. Once you have gone your family will not receive any of the money you have left behind as it will all go to the annuity provider.
3. Rates Subject to Fluctuation
Although you may not be subject to fluctuations from the stocks and shares market, you will be subject to changes from the investments annuity providers use. If these are not performing well when you retire, you may receive a lower rate. Rates are also getting lower each year as people are living longer.
Buying an annuity remains the most popular way of turning your pension savings that you’ve built up into your regular income source. You may be approached by firms which will tell you that there is another way to withdraw your entire pension in a lump sum. Make sure you are informed of the dangers of these by reading our previous post on pension release schemes. Buying an annuity is a big decision so make sure you shop around for one that’s right for you. Also, make sure you keep informed about the changes coming into place in April 2015.