Pension Annuities

One of the first things to consider when deciding whether to choose a pension annuity is the details of your pension scheme or pension schemes.

Some people have a number of pension schemes with different amounts saved, different features and different benefits. When approaching retirement, pension providers typically issue an annuity quotation.

In order to plan your pension annuity and take advantage of the best possible offer, it is a good idea to assess your situation and your retirement needs. Answering a number of questions relating to your individual situation may help you to plan your pension annuity. For instance:

• How much retirement income do you require?
• How much are all your pension schemes worth?
• Do you need/desire a cash lump sum from your pension?
• How much of your pension do you wish to devote to providing an income?
• Do you wish your dependants/anyone else to receive an income in the event of your death?

Pension annuity tax

The income from your annuity is subject to tax, and your pension provider should illustrate these figures. To accurately assess your financial situation and plan for retirement, it is important to work out your post-tax retirement income.

Choosing your pension annuity

Once you have researched your pension situation and your retirement intentions, it remains to choose a pension annuity or other pension option that meets these wishes.

When you are nearing retirement, your pension provider may send you a quotation regarding your pension scheme.

If you are not automatically sent a pension quotation, you should ask your pension provider to send you one.

A pension quotation will typically include the following information:

• The value of your pension scheme and which investment funds the scheme is linked to, if relevant
• The value of the annuity income your pension company will pay to you
• The features and benefits of the pension annuity
• The value of any pension commencement lump sum

Why should I ask for my pension quotation?

Getting a full quotation from your provider is a way of arming yourself with knowledge about your pension plan or pension plans. You therefore know the facts regarding your pension scheme, its value, and how the fund will be paid to you. Once you have this information, you can use it as a base for comparison with other pension annuities.

After conducting research regarding your annuity, you may decide that you wish to take your annuity to the open market and try to find a more competitive pension provider to handle your annuity.

Choosing the Open Market Option

The annuity offered by your pension company may not be the most competitive scheme and choosing the open market option could increase the value of retirement income. The open market option is a legal right to buy a pension annuity from any provider on the market.

This can apply to both a standard annuity and a with-profits annuity. Choosing the right pension annuity is extremely important, because once purchased, annuities cannot be switched to another annuity provider, changed to a different type of annuity, or altered in any other way.

How much could the OMO (open market option) increase my annuity by?

The OMO could provide a substantial increase in annuity payments.

Taking the OMO could increase income by 10 per cent, whilst upgrading your annuity to an enhanced annuity or impaired annuity could significantly increase retirement income. The better the annuity rate, the more money the retiree will receive for the rest of their life.

When a pension provider issues an annuity quotation, there could be a considerable difference between the amount offered, and the annuity income that the pension holder could actually receive.

It is worth remembering that retirement income can change in value, due to the way economic and investment markets change and affect pension funds.

You might qualify for an enhanced annuity or impaired annuity

Many pension companies do not know the full details of their pension holders. For this reason, you may be entitled to an enhanced annuity.

This is relevant for people with a lower than average life expectancy, perhaps due to medical history, chronic conditions, smoking or other factors.

An enhanced annuity provides a higher level of retirement income for the pension holder, although not all pension companies will provide enhanced annuities. Read more about enhanced annuities and impaired annuities below.

Finding the right annuity option

Understanding which annuity is the most effective for your circumstances can be difficult. There are a variety of pension annuities on the market, including conventional annuities, enhanced annuities, with-profits or unit-linked annuities, investment annuities, joint life annuities, impaired annuities and more.

When you receive a quotation from your pension provider, you may wish to shop around to try and find a more attractive annuity.

This is called taking the Open Market Option. By law, you are entitled to take the value of your pension scheme and buy an annuity off another provider.

You may choose to do this because another provider offers better terms and can provide you with a larger retirement income, or another provider can satisfy your retirement needs whilst your current provider cannot.

Choosing a Pension Annuity

By shopping around, pensions experts estimate that some retirees can increase their retirement income considerably, in some cases by 50% or more. This will depend on the age and health of the pension scheme holder.

This is extremely significant because it influences the level of annuity payments received by the pension holder every month.

Once you have decided to shop around for a pension annuity, it is a good idea to make sure you know the facts of your pension scheme, including your projected retirement income.

You can then proceed to assess your pension annuity options and choose the one most suitable for you.

Many people are entitled to the state pension. Even though you are planning an annuity, you should bear in mind the retirement income that will come from your State Pension benefits. Other forms of retirement income can include other pension schemes, savings and investments.

How much State Pension am I entitled to?

To find out what level of State Pension you are entitled to, please download the BR19 form using the link below.

The BR19 is a request for the government to provide you with a pension forecast for your state pension.

What other types of State Pension are there?

Other types of pension scheme related to the state pension include the graduated pension and the state earning related pension. Both of these elements should be included when seeking a pension forecast. Some workers may have chosen to opt-out of receiving their state pension, a decision known as contracting out.

How is the state pension paid?

The State Pension is paid directly into the bank, building society or other savings account nominated by the pension holder. If the state pension holder needs someone else to collect their state pension, it can be sent by cash or cheque to a Post Office.

State pensions can be used to top up your annuity and should be considered when planning your retirement.

Once you have decided that you wish to purchase a pension annuity, it is time to work out exactly which annuity suits your retirement needs. This will depends on your own needs and the needs of your family.

Pension Commencement Lump Sum

Many people choose to take a Pension Commencement Lump Sum and use the rest of their pension fund to purchase an annuity.

This block of cash is tax-free and can be spent, saved or invested as the policyholder sees fit.

Frequency of Annuity payments

Once you have worked out how much money remains with which to purchase your annuity, you can choose the frequency at which annuity income is paid.

Usually, pension annuity payments are made on a monthly, quarterly, half-yearly or annual basis. A monthly annuity payment is the most common way of receiving pension annuity, as most people prefer this to make budgeting easier, having always been paid on a monthly basis.

Timing of Annuity payments

If you would like your annuity payments to start as soon as your pension fund has been created you receive payments in Advance, whilst if payments start at the end of your payment term, these payments are In Arrears.

Annuity payments with or without proportion

If you receive your annuity payments in arrears, and die between two payment dates, with/without proportion describes how annuity payments are made. With Proportion payments are made as a proportion of your annuity, whilst Without Proportion means that last annuity payment before death will be the last.

An annuity guarantees an income for life so for many people, even following the significant changes to pensions legislation which has given greater freedom and more options open to those about to retire, this will probably still be the best option available.

With many pensions however, their annuity does not have to come from the provider of the scheme that their pension contributions have been paid into.

The first thing to consider is whether to exercise the open market option.

If another provider offers better annuity rates, thereby providing a higher pension, the fund can be transferred and the pension then starts immediately with the new company. Scouting around the market for good deals may affect income levels by as much as 30% to 40%.

There are 3 main types of annuities available as follows:

• Joint Life Annuity
• Level or Increasing Annuity
• Enhanced Annuity and Impaired Annuity

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Joint Life Annuities are suitable for people who have a financially dependent person or persons. A joint life annuity will allow pension payments to be made to this person in the event of the death of the pension scheme holder.

When it comes to a spouse or other older dependent, the annuity buyer decides the percentage of the annuity payable to the dependent.

If the dependent is a child, the income from the annuity continues until a certain age.

Joint Life Annuity and Guarantee Period

Another annuity option is to guarantee then income for between one and ten years, regardless of whether the pension holder dies during this time-frame.

Usually, annuity income is payable for life and ceases when the pension holder dies.

If you have selected a Guarantee period, the annuity payments will continue to be made to a beneficiary or beneficiaries even after your death.

These payments are subject to tax. Furthermore, to guarantee retirement income for a period after your death will possibly lower retirement income whilst you are alive.

Joint Life Annuity, Guarantee period and overlap

If you have selected a guarantee period as part of your joint life annuity, it is also necessary to select whether, in the event of your death, annuity payments start during the guarantee period (known as With Overlap) or after the guarantee period (Without Overlap).

Adding Annuity Protection to a Joint Life Annuity

Adding annuity protection (sometimes called value protection) provides the option of paying the value of the pension fund, less the annuity income you’ve received plus taxes to the nominated beneficiary.

Furthermore, the pension holder can decide at what point the benefits are paid. If you protect your pension savings, your retirement income whilst alive will be lower

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Level or Increasing Annuity

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Inflation can erode pension income over time, however there are annuity options to try and prevent this. For instance, you can choose to increase your retirement income on annual basis.

This can be achieved by setting a fixed increase (up to 8.5% over the course of a year), or by linking your retirement income to the Retail Price Index.

Starting income

However, the starting income from an increasing annuity is likely to be lower than the starting amount of a level annuity that does not increase.

Furthermore, it may take several years before increasing annuity income reaches the same amount as a level annuity. Once this amount is reached, the income will continue and a higher annuity income is possible.

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Enhanced Annuity and Impaired Annuity

Although annuities are a long-standing financial services product, enhanced annuities and impaired annuities are relatively recent additions to the market.

The basic premise is that due to lifestyle or medical conditions, postcode and occupation an annuity buyer may qualify for a different type of annuity, known as either an enhanced annuity or an impaired annuity.

Currently, only a small proportion of people think that they could qualify for an enhanced or impaired annuity uplift, and do not take advantage of this opportunity. Failing to recognise that you qualify for an enhanced or impaired annuity could mean losing out on significant increases in retirement income.

Why might I qualify for an enhanced annuity or an impaired annuity?

Literally thousands of conditions might mean someone qualifies for an enhanced annuity or an impaired annuity.

These can include common chronic diseases such as asthma or diabetes, or serious medical problems such as heart attacks or types of cancer. In reality, conditions that are well-controlled and endured by the patient as part of daily life may qualify them for an enhanced or impaired annuity, particularly if more than one condition is present.

How does an enhanced or impaired annuity benefit me?

A retiree purchasing a pension annuity could see their retirement income soar, particularly if a combination of conditions can be shown.

For instance, a person that smokes and has diabetes could see a large increase in their retirement income.

Enhanced or impaired annuity determination rule

Every annuity provider has a different definition or rating for different health conditions. For instance, enhanced annuities may cover minor conditions whilst impaired annuities cover major conditions.

Applications for these annuities are based on a points score card. In some cases, the pension company may ask for a doctor’s report, and will base the increased retirement income on this report.

Some companies cover the cost of the medical report or roll it up into the annuity, whilst some companies require the patient to pay for their own medical report.

Boosting your annuity could help you enjoy a more secure retirement, with larger annuity payments. Thousands of retirees could increase their annuity by applying for an impaired annuity that provides a higher income for those in ill health or leading certain lifestyles.

1 in 10 could qualify for impaired life annuity

Pensions experts estimate that just one in ten retirees who could qualify for an enhanced or impaired life annuity are actually applying for one.

Impaired or enhanced annuities reward customers for poor health and lifestyle by paying out larger annuity payments.

Impaired or enhanced

Qualifying for an impaired or enhance annuity may be as simple as asking your annuity provider to take your medical history into account.

Furthermore, enhanced annuities are available to customers that smoke, are overweight, or suffer from high blood pressure or cholesterol. Impaired annuities may be available to people with serious illnesses or health problems, including diabetes, cancer or heart disease.

Many people approaching retirement have never heard of enhanced or impaired annuities.

Each annuity company has individual definitions and ratings for health conditions, meaning that taking an open market option can find the best retirement income from an enhanced or impaired annuity.

Once you have filled out a pension annuity application, the retirement specialist will send a number of important documents.

The pension holder should read these documents carefully to make sure that they are the best retirement solution. These documents will include:

A letter clearly showing which annuity has been chosen and the features and benefits of this annuity.
A personal illustration showing the annuity income of the pension holder, from different annuity companies.
A Key Features Document that outlines the commitments, goals and risk factors associated with the annuity chosen.

How is my pension fund transferred to purchase an annuity?

Once the pension holder has decided which annuity to purchase, the next stage is the payment of benefits. This will be arranged by the retirement specialist you have chosen, and the transfer of monies will be completed by the pension provider.

The annuity purchase process can take between four and six weeks to complete.

When economic conditions are uncertain, many people may choose to put off buying an annuity with their pension.

This is known as delaying your annuity. For instance, if a pension fund is linked to an investment fund, and this is performing badly due to current market conditions, many pension holders may wish to defer their pension annuity for a certain period.

Is deferring my annuity a good idea?

Delaying your annuity may be a good idea, but it is a decision that should be thought through in detail. There are a number of important questions that those considering delaying buying their annuity should ask.

For instance, can you afford to forego the income if you have already retired? Will the situation have improved and markets recovered after the delay? If interest rates fall, what will happen to your pension? How will annuity rates changed over this period? Will you qualify for an enhanced or impaired annuity after deferring?

Depending on your individual pension circumstances, it may make good financial sense to delay your annuity, but the above points should be considered before making a decision.

Some people may not need the security and regular payments provided by a conventional annuity. In this instance, there are alternatives to buying an annuity, the most common of which are detailed below.

Why would I not buy an annuity?

Not buying an annuity may increase income but opens the pension fund to risk.

Pension holders may prefer to use self-investment to maximise income, protect their pension pot for their family, vary their income, generate income in a different way for tax reasons, or simply desire higher value than a conventional annuity can provide.

Alternatives to Annuities

All of the alternatives to choosing an annuity carry elements of investment risk, and are really suitable for people who can afford this risk. Alternatives to buying an annuity include an unsecured pension, income drawdown, phased retirement, alternatively secured pension and others.

Once you have purchased an annuity, you cannot change your mind, so at least investigating the alternatives is a good idea. It is possible to avoid buying an annuity at all by relying on income drawdown until the age of 75, and then choosing an alternatively secured pension. This is a complex area of financial services, because although not choosing an annuity provides flexibility, it may attract extra risks and costs.

Income Drawdown

Income drawdown is a way of taking income directly from your pension pot whilst it remains invested. The aim is to keep the fund topped up by investment growth. Those choosing income drawdown can stop at any point and purchase an annuity. If the pension holder dies during income drawdown, their heirs can inherit the remainder of the fund.

Alternatively Secured Pensions

Upon reaching the age of 75, the pension holder must either purchase an annuity or an alternatively secured pension to keep money invested. ASP is similar to income drawdown although it is more limited. When the pension scheme holder dies, the remaining fund will continue to provide an income for the dependants, but it cannot go into the estate.

Those who go into income drawdown risk seeing lower rates of retirement payment when they come to buy an annuity, and also miss out on the income that they would have gained.

Furthermore, the pension fund may fall in value over time, and charges such as investment management charges or administration charges may add up over time.

Income drawdown and ASP are thought to be most suitable for those with a large pension fund of over £100,000, or those who have significant alternative investments that they can use to retire with.

Phased Retirement

Phased retirement is a form of pension plan that accepts existing funds and gives the pension holder the option of buying an annuity or entering income drawdown in several stages, rather than in one go.

Each year, someone in phased retirement chooses how much income is needed and cashes in as much of pension fund required to provide the income. You can take out a phased retirement plan at any time after retirement age.

Phased retirement is suitable for those people who wish to vary their income from year to year, wish to benefit from pension fund increases and accept the risks if it falls, have alternative sources of income and do not need the security of a conventional annuity, wish to maximise the benefits that their family receive.

Phased retirement does not guarantee income and carries greater risks than conventional annuities

This section details the terms used in relation to pension annuities. Annuities are a complex financial product, meaning that some of the terms may be unclear at first.

Use the annuity glossary as a guide to better understand what pension annuities are and how they can improve your retirement income.

Annuity (pension annuity) – A contract bought using a pension fund. The annuity provides a retirement income in regular payments for the rest of the pension holder’s life.

Annuity payments – A monthly payment made to the pension holder who has purchased an annuity. The level of annuity payments depends on the size of the pension fund, the annuity option chosen, the age, gender and health of the pension holder, and the additional benefits included in the annuity.

Annuity protection (value protection) – Annuity protection guarantees that the pension fund (less annuity payments already paid) is given to a named beneficiary after tax. Generally an option only for deaths before the age of 75.

Conventional annuity – A conventional annuity is a simple form of pension annuity that provides an income for life. These annuity payments are not subject to annuity risks such as investment risk or mortality risks. Income will continue to be paid out until the death of the annuity holder. Conventional annuities are the most common retirement income annuity.

Defined Benefit Pension Scheme (final salary pension scheme) – This type of pension scheme clearly outlines the retirement income that the employee gets, usually based on the number of years worked and the final salary before retirement or changing jobs.

Defined Contribution pension scheme (money purchase scheme) – This type of pension scheme describes a pension where the employer and employee pays a set amount into a pension fund. This type of scheme is subject to investment risk.

Enhanced Annuity – Enhanced annuities are a type of annuity that gives the pension holder a higher income due to a medical or lifestyle reason that shortens life expectancy. For instance, this may include habits such as smoking or drinking, medical history or lifestyle.

Escalation – Escalation is a way in which annuity income climbs every year. Annuities can be set at no escalation (known as a level annuity), a fixed increase annuity, or an annuity linked to the retail price index.

Guarantee period – If the pension holder dies after purchasing the annuity, they may feel that they haven’t received good value for money. Therefore, annuity buyers can stipulate a minimum guarantee period that means the annuity income will continue to be paid during the period, regardless of the death of the buyer.

Impaired Annuity (Impaired Life Annuity) – Impaired annuities are a type of annuity that pays out a higher income than an enhanced annuity. Impaired annuities are suitable for those people that have a significantly lower life expectancy due to an ongoing medical condition. Conditions that may qualify for an impaired annuity may include heart attacks, heart surgery or angina, life threatening cancers, organ diseases, strokes, diabetes and more.

In Advance/In arrears annuity payments – The annuity buyer can choose to set up annuity payments so that they start as soon as the annuity has been set up (known as advance) or at the end of the chosen payment frequency (in arrears.) Advance payments are more common.

Investment-linked Annuity – Investment-linked annuities are a type of annuity from which the retirement income may fluctuate. The value of the fund is linked to the performance of an investment fund, or spread across several investment funds. When investment returns perform well, the income from the investment improves and annuity income payments will increase. However, if investment returns are poor, then the annuity income payments may also fall. Investment annuities include with-profits annuities and unit-linked annuities.

Joint Life Annuity – A joint life annuity will transfer annuity income to a named dependant in the event of the death of the annuity buyer. The buyer chooses whether income is paid to a dependant.

Occupational pension – An occupational pension is a retirement income received from a scheme provided by an employer or previous employer/employers.

Open market option – An open market option provides the ability for the annuity buyer to use their pension fund to purchase an annuity from any annuity provider. The buyer can search the market for the best and most appropriate rate.

Annuity payment frequency – Annuity buyers can choose the frequency at which their annuities are paid. The frequency of the payments will depend on the retirement circumstances of the buyer. Annuity income is usually paid monthly, quarterly, half-yearly or on an annual basis.

Pension Commencement Lump Sum (Tax-free cash) – A percentage of a pension fund can usually be taken as a cash lump sum which is tax-free. This used to be referred to as a tax-free lump sum, and may be spent however the pension holder sees fit.

Pension fund – The pension fund refers to the total value of the pension plan built up through years of contributions, including those made by your employer or any tax relief or national insurance contribution rebates.

Personal pension – A personal pension is a financial services product taken out by an individual using an insurance company or bank. This type of pension scheme is available to both unemployed and self-employed individuals.

Short-term Annuity – Some retirees purchase a short-term annuity with some of their pension fund, leaving the remainder invested.

Third-way products – Third-way products are a financial services product that combines a guarantee and an investment.

Unit-linked Annuity – Unit-linked annuities ties the annuity income to the performance of an underlying investment asset. This asset is usually shares in a company or companies, chosen by a fund manager. Retirement income will vary and is not guaranteed.

Unsecured pension (Income drawdown) – Upon retirement, the pension holder can keep their pension fund invested and take income from that invested fund rather than purchase an annuity. There is an element of risk in this and it is generally recommended for those with a large pension fund or those with alternative sources of retirement income.

With-profits annuity – A with-profits annuity directly links annuity income with the performance of a with-profits fund. Therefore, the retirement income is linked to an annual bonus rate declared by the annuity provider, rather than a guaranteed lifetime income.

With/Without Overlap – Overlap is relevant in the case of joint life pension annuities with guarantee periods. If the pension holder dies during the guarantee period, with overlap means payments will begin immediately (including tax and less the annuity income already taken), whilst without overlap means that the dependents payments will start after the gua12rantee period.

With/Without proportion – Proportion is relevant to those annuity buyers who have chosen to receive their annuity income payments in arrears. With proportion means that the final proportionate payment is made to your estate to cover the period between last payment and death. Without proportion refers to final annuity payment a the last scheduled payment before death.