Annuity purchase is possibly the most difficult financial decision that you will make in your life. It is a one-off choice and if you get it wrong, there is no turning back. If you are approaching retirement, it is vital that you take professional advice to ensure that you fully understand the implications of your actions. 

Evolve Financial Planning advises on all types of retirement planning solutions, from traditional annuities, investment linked annuities, income drawdown, phased retirement, phased income drawdown, retirement through occupational pension schemes to non pension based retirement planning.

As annuities are the most appropriate solution for the vast majority of the UK population, our article will concentrate on this particular element of retirement planning.

Open market option

At retirement, an annuity is usually purchased from an insurance company, which will convert your pension fund into a guaranteed income for the rest of your life. What many people fail to recognise is that you are by no means obliged to purchase an annuity from your existing pension provider. In the vast majority of cases, you will be able to achieve a favourable rate by electing to take the ‘open market option’ and shop around for the best annuity rate.

Enhanced and impaired life annuities

If you smoke more than 10 cigarettes a day and have done so for the past 10 years, you may qualify for an enhanced smoker’s annuity.

Similarly, if you are in ill health, have suffered a serious illness or have undergone surgery that is likely to reduce your expected life-span in the eyes of the underwriters, you may be eligible for an impaired life annuity. It is always worth checking whether you are eligible for improved rates and any good adviser will always ask you about your state of health before proceeding with an annuity recommendation.

Guaranteed annuity rates

Many ‘old style’ Retirement Annuity Contracts (also known as Section 226 plans) and a few old Personal Pension Plans offer attractive guaranteed annuity rates through the contract itself. These are often well in excess of the best open market rates. Care needs to be taken as these guaranteed rates are sometimes only available at your normal retirement date or on a pre-ordained basis such as a single life, level annuity with no guarantee period, payable annually in arrears.

Whether you are eligible for an enhanced annuity or not, or have attractive guaranteed annuity rates available to you, you will need to select the exact basis upon which your annuity will be paid to you. Options include guaranteed periods, spouse’s pensions, escalation and payment frequency. We will explore each of these in turn:

Guaranteed period

A guaranteed period of either 5 or 10 years can be selected at outset to ensure that your whole fund would not be lost if you were to die in the early years. The cost of this option is generally quite small, particularly on joint-life annuities or where the annuitant is relatively young.

Spouse’s pension

This option allows you to ensure that your spouse would continue to receive annuity payments after your death. The proportion payable must be selected at outset and will usually be 50%, 67% (two thirds) or 100%. 

Escalation

Through an escalating annuity, you can stipulate that your income will rise by 3%, 5% or RPI inflation each year. Naturally, this option will produce a lower initial income but will ensure that your annuity payments retain some or all of their purchasing power during your lifetime.

Payment frequency

Annuities are normally paid on a monthly basis although it is possible to elect for quarterly or even annual payments to suit your requirements. This income can either be paid in advance or in arrears. The highest annuity would be on an annual in arrears basis as you would have to wait a full year before your first payment. When comparing annuity providers it is extremely important to ensure that you are comparing like-for-like as the payment frequency can distort the annuity rate quite considerably.

Should you wait?

There is no denying that annuity rates have fallen considerably over the past 10 years or so. However, you should remember that inflation has also fallen and in addition, we are all living longer. Improved mortality rates should lead to declining annuity rates in the future as insurance companies will expect to have to pay out on the annuities for longer.
In addition, more and more people in poor health are taking advantage of impaired and enhanced annuities. This means that many of the ‘substandard life risks’ are being removed from the ‘standard’ annuity pool, which means that there will be less of a mortality cross-subsidy. This should exert downward pressure on annuity rates for healthy people.

In conclusion, if annuity purchase is the right thing for you, there is probably no benefit in putting it off in the hope of better rates in the future. You should concentrate on making sure that you purchase the most appropriate annuity for your personal circumstances.
Please feel free to contact us if you would like more guidance on the above issues.