What is an annuity? Five things you need to know
If you’re a keen reader of the financial press you will have seen a lot about them over recent years – but what is an annuity? Until recently at least, it was the most common route for people to fund their retirement, but there has been some controversy over falling annuity rates. To explain annuities, here are five things you need to know.
1. A conventional annuity will pay you a guaranteed income for the rest of your life
It works like this: you use your pension pot to purchase an annuity with a provider, and they will pay you a guaranteed level of income for as long as you live. It offers you the security of knowing how much money you have coming in, without any worry about it stopping.
2. There are a wide range of annuity products, and you MUST shop around
One of the reasons why annuities receive bad press is because thousands of people have ended up with inferior deals. In most cases, when you purchase an annuity it cannot be undone.
How has this happened? A key factor is that many people don’t shop around. There is no restriction to stay with your pension plan provider. Look at others, find the best rate, and make sure your circumstances are taken into account.
3. Your health status could mean you qualify for an enhanced annuity
If you have a health or medical condition, or if you are a smoker, you could qualify for an enhanced annuity. This would pay you an even higher level of income.
4. There are other features available too
Two of the risks associated with an annuity are you might not live long enough to receive back the full value of your pot, and the rising cost of living could erode the real value of your income over time. Yet there are annuity options available that can address these issues.
- You can arrange an annuity that would continue to pay an income to your spouse or partner after you die, so they continue to benefit from your pension. Previously this would only pay for a maximum of 10 years, but the maximum guarantee period has now been abolished.
- You can also arrange an annuity that increases in payment over time, thereby helping you keep pace with the cost of living.
5. The new pension rules mean you no longer have to rush this decision
There are genuine benefits to taking out an annuity, despite what you might read in the financial press – but you don’t need to decide straight away.
You can keep your pension invested in retirement (known as drawdown), and make withdrawals as and when you need to. It will mean accepting some level of investment risk, but in your early years of retirement, you might be prepared to do just that.
When you get older, say in your 70s, you might want to arrange a secure, guaranteed income for the rest of your days. This is the point where you could turn to annuities, and look for the best deal available at that time.
Ultimately, it’s all about having a considered financial plan for your pension fund – and financial advice is highly recommended to get that plan right for you.
Annuity rates depend on your individual circumstances such as age, health and lifestyle factors as well as the rates available at the time of purchase. A conventional annuity has no cash-in value to you as an individual and once selected the options chosen cannot usually be changed.
For retirement solutions such as drawdown, your capital is at risk so you may get back less than you originally invested. The value of investments and the income from them may fall as well as rise. If you take too much income too quickly your fund could become depleted or run out altogether.