Even though you have spent your entire life saving money in your pension plan, you will not be able to just draw it all out at once. You will need to convert your pension money into cash that you can use for the rest of your life and this is usually done by buying an annuity. You will need to buy an annuity with your personal pension funds, stakeholder pensions and any money-purchase employer schemes that you have been paying into.
What will affect your annuity rate?
An annuity is a type of financial product where you can exchange a lump sum of money for an income. How much you will get depends on a few things.
The amount of money that you have been able to save over the years is the first thing that will be looked at. Where you live is another factor that will affect how much you get. Sometimes annuity providers will base annuity rates on the mortality rates in different parts of the UK. You will get higher rates if you live in an area that has low mortality rates.
Your health is yet another factor that is taken into consideration. If your health is poor, annuity providers will assume that you have a lower life expectancy, which means a shorter period for them to pay out for. This could increase the rate that you get, or you may qualify you for enhanced annuities.
The annuity rates offered by individual annuity providers are also a factor that will affect how much you get. There are many different annuity providers and a lot of competition in the annuity market, so rates may vary between providers. It is very important that you shop around when you are looking to purchase an annuity.
Who should buy an annuity?
You will need to be a member of a defined contribution pension schemes in order to qualify. If you belong to an employer’s final salary scheme, your pension is normally paid directly from the scheme, so you will not have to worry about annuities. Some money purchase pension schemes from employers allow the pension trustees to buy an annuity on your behalf. You are able to find options you have from your scheme manager.
Your pension provider will prompt you to buy an annuity between five years and six months before you retire. If you show interest in buying an annuity, you will get a follow-up pack six to ten weeks after you retire.
There are a few factors that affect the annuity rate that providers can offer you, over and above your own personal circumstances. They include:
The value of government bonds which insurance companies buy to fund annuities.
The Bank of England base rate, which can influence the level of interest the government, will pay on its bonds.
The demand for gilts affects annuity rates as well. When they are in high demand, the interest payments fall, which depresses annuity rates. When they are in low demand, rates can rise
Other monetary policy – quantitative easing (QE) has also affected annuity rates, as this pushes gilt yields down further, as the purchase of gilts in mass quantity by the Bank of England has reduced interest payments. For more information on your annuity options check out this article by the BBC.
The Pros and cons of annuities
Benefits of annuities
Annuities provide you with regular payments from the day you retire until the day you die. Your investment risk is minimal, unless you choose to go for an investment-linked annuity.
It is possible for you to choose annuities that will increase in value annually in line with inflation. This will ensure that your money keeps up with the rising prices of goods as you get older.
If you are in bad health or impaired, enhanced annuities pay will release a higher income than standard annuities. You can get as much as 65% more with these annuities. It is because the insurer will have to pay out for a shorter period of time. You will also have the option to sell life contingent annuity if you are in need of urgent cash.
The drawbacks of annuities
One major drawback with annuities is the fact that once you have handed your money over, you cannot get it back. It is for this reason that you need to be 100% sure that buying an annuity is the right choice for you.
Should you die soon after buying the annuity, the income you receive will not be anywhere near the amount that you have already paid in. There are steps you can take to protect yourself from this potential disaster, but you should consult a professional to find out the details of how to go about it.
You need to think twice before taking out an annuity with your pension provider. You need to shop around, which is known as the open market option (Omo). Using the Omo will give you more retirement income options. You may even get higher rates than you would from your pension provider, sometimes as much as 20%.