What is an annuity? An annuity is a financial product sold by
an insurance company which guarantees to pay the holder a certain amount of money every
month for the rest of their life. How much will the annuity pay? This depends on a number of factors, including
how much money is in your pension pot, how old you are when you buy your annuity, what
annuity rates in general are like when you buy it, and what the state of your health
is. What is happening to the rules around annuities? Until April 2015, most people had to use their
pension funds to generate an income for their retirement. In the majority of cases, this
meant buying an annuity.
But changes in the law mean that there is
no longer the obligation to generate an income from your pension fund. Why have annuities been criticised? Increasing longevity and falling interest
rates since the financial crisis of 2008 mean that annuities over the past few years have
paid out less than in the past. Another issue is that an annuity contract
is generally irreversible: once you have bought one, you cannot cash it in or try to get a
better rate. You need to be certain that a secure income in retirement in exchange for
your pension funds is your preferred option.
A lot of annuity customers have also automatically
taken the annuity on offer from the provider of their pension fund, who may not always
provide the best income. If opting for an annuity it always pays to shop around to see
whether another annuity provider may offer a better rate, especially if you are in poor
health. Do annuities have anything to recommend them? Despite these issues, buying an annuity could
still be the right thing to do in many circumstances. They offer a guaranteed income which will
not fall if, say, the stock market plunges.
For those who wish to take no risk with their
retirement income and want certainty over the level of income they will receive, an
annuity may still be the best option. The 2015 law changes mean that more people
are likely to keep their pensions invested after they retire, or buy assets such as buy-to-let
property: but though these options give greater flexibility and potentially better death benefits,
there is a risk of losing money. Also, an annuity means you will never run
out of money: if you take an income from investments, there is a chance you will exhaust your fund
before you die. What kinds of annuities are available? There are numerous types of annuity, and which
one will suit you best depends on your personal circumstances.
Index-linked or escalating annuities These pay an increasing amount of money every
year in line with inflation or by a fixed percentage. The trade-off is that in the early
years they pay less than level annuities, where the income stays flat for the rest of
your life. Joint-life annuities These are aimed at couples. The annuity will
continue to pay out after the first partner dies, unlike single-life annuities.
From April
2015, it will be possible for a joint life annuity to be paid to anyone, rather than
specifically to a spouse or financial dependant. Enhanced annuities This type is for people who have health conditions,
such as heart disease, diabetes or high-blood pressure, which could reduce their life expectancy.
Enhanced annuities pay higher income than normal annuities. Some lifestyle choices such
as smoking may also give an increased rate. I want to sell my annuity for cash - how do
I get the best deal? The first thing is to be sure that you can
manage without the regular income.
Whilst a lump sum is obviously attractive, you will
have been used to having the income coming in and you need to be sure you can live on
a reduced income. With an annuity of 25.45 Per month that
is probably not much of an issue, but those with larger annuities need to be careful not
to be tempted by the thought of a cash lump sum and then find they cant manage on their
reduced income. Those receiving benefits such as housing benefit
or pension credit should be especially careful, as it is very unlikely that your benefit would
be increased even if your income fell as a result of selling an annuity. Also, if you
receive a large lump sum in payment, your benefits could be reduced.
The next question is working out what would be a fair price for your annuity.
A simple
way of looking at it would be to ask yourself what payments you are likely to receive for
the rest of your retirement. To give some round numbers, if the actuaries
thought that you were likely on average to receive the annuity for another ten years,
then you might think it is worth 3054 (25.45 A month times twelve months times ten years).
But the amount you would be offered is likely to be considerably lower than this.
There are a number of reasons why you might get less than you expect.
There will be costs to the company which provided your annuity in handling the transaction and
they are allowed to deduct these from the value of your policy.
There will also be costs to the company which buys your annuity (which could be the same
firm but could be someone else) and they will knock these off any offer that they make.
These could include the costs of any new medical checks that they might want to undertake,
the costs of advertising their services, their own profit margin and so on.
Another reason why you might get less than you expect is that the insurance industry
worries about something called adverse selection this is the risk that the
people who are willing to sell their annuities might be the people who know that they are
in poor health. For this group, a cash lump sum may be preferable
to an income stream that lasts as long as they live. Although the buyer will ask health
questions, the seller of the annuity knows more about their health than the buyer, and
theres a risk that annuities which are put up for sale will continue in payment for
less time than an average annuity.
You ask an important question about whether
you should sell to your provider or on the open market. In my view there is no question
that you should get quotes from as many people as possible.
Its very hard to know what the right price is for an annuity, but at least if you
have several offers then you can choose the best one if you decide to proceed. The potential
lack of competition in this market is another reason why you might not get as much as you
expect. The Government has introduced a number of
measures to try to protect consumers, as it is concerned that people may not get value
for money.
One such measure is that anyone who makes
you an offer has to tell you what it would cost to buy the annuity that you have today
on the open market. This will give you some benchmark as to the underlying value of your
annuity. There is also a requirement to take financial
advice before selling your annuity if it is above a certain size. The Government has yet
to specify this threshold, but it generally regards annuities worth more than 30,000
as being important enough to be worthy of seeking advice.
This does not apply to you, and paying for advice would probably not be cost effective
for a relatively small annuity such as yours.
But you can contact the Governments free
Pension Wise guidance service if you want someone to explain in more detail how the
process will work. In terms of how you can take the money, you
can take it all as cash in a lump sum or you can invest it in a new product such as a drawdown
account and take the money gradually. In either case you should expect to pay tax
at your marginal tax rate - nil on less than 11,000, 20 per cent, 40 per cent or 45
per cent - on the money when it is finally withdrawn. The Government explains income
tax rate bands and personal allowances here.
Finally, you should be aware that taking the
money as a lump sum could mean you end up paying more in tax than if you had continued
to take regular payments under the annuity, depending on what other taxable income you
have. Contact the Governments
https://www.Pensionwise.Gov.Uk/ The Government explains income tax rate bands
and personal allowances here https://www.Gov.Uk/income-tax-rates/current-rates-and-allowances.
