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Retirement Planning
September 25, 2023

Annuities Explained: Guaranteed Income For Life

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Planning for retirement is a significant milestone in anyone's life, and one of the key decisions you'll face is how to secure a stable income for your retirement years. One popular option that provides financial security for life is a pension annuity. In this guide, we'll explore the ins and outs of pension annuities, helping you make informed choices about your retirement income strategy.

What Is a Pension Annuity?

A pension annuity is a financial product that offers a guaranteed income for the rest of your life, regardless of how long you live or how the stock market performs. This reliable stream of income can provide peace of mind, especially for individuals with a low tolerance for investment risk.

Accessing Your Pension Funds

Typically, you can take 25% of your pension as a tax-free lump sum and use the remaining 75% to purchase an annuity. However, you don't have to take your entire pension all at once, and you're not obligated to choose an annuity. You have the flexibility to explore various retirement options to meet your specific needs.

Comparing Annuity Rates

Several insurance companies offer annuities, and the rates they provide can vary. It's important to note that the pension provider you are currently with may not offer the most competitive rate. To ensure you secure the best deal, consider comparing annuity quotes from different providers.

Factors Affecting Annuity Income

Several factors influence the amount of annuity income you can receive:

  1. The Size of Your Pension: Generally, the more of your pension you use to purchase an annuity, the larger your income will be. However, you don't have to lock your entire pension into an annuity; you can choose to purchase annuities gradually.
  2. Annuity Rates at the Time of Purchase: Annuity rates are influenced by gilt yields, which respond to changes in interest rates. Higher yields often lead to higher annuity rates, while lower yields may result in lower rates.
  3. Age, Health, and Lifestyle: Older individuals tend to receive higher annuity incomes. Moreover, disclosing health conditions or unhealthy lifestyle choices could qualify you for an enhanced annuity, providing more income based on lower life expectancy and other factors.

Annuity Features and Options

When setting up an annuity, you have various options to customize your income:

  • Rising Income: You can choose to have your income increase over time.
  • Payment Frequency: Decide whether you want to receive payments monthly, quarterly, semi-annually, or annually.
  • Spouse's Benefit: Choose whether your spouse will continue to receive payments after your passing.
  • Guarantee Period: Ensure income payments continue for a set duration even if you pass away.
  • Value Protection: A lump sum is paid to your beneficiaries upon your death, minus any income received.
  • Index-Linked: Your annuity income increases in line with an index, such as inflation.
  • Increasing Income: Set your income to rise by a fixed percentage annually.

Tax-Free Cash Option

While you can typically withdraw up to 25% of your pension as tax-free cash, you aren't obligated to do so. Some individuals may choose to allocate their full pension value to increase their annual income, while others prefer to receive a tax-free lump sum for other purposes, such as savings or investments.

Protecting Against Inflation

Considering the potential long-term nature of annuity income (20-30 years or more), it's crucial to address inflation. Annuities can provide options to protect against inflation, such as increasing income by a fixed percentage each year, ensuring your purchasing power remains intact, but this will reduce your initial income.

Payment Frequency and Continuation After Death

You have the flexibility to choose how often you want your income paid, whether in advance or arrears. Additionally, you can decide whether you want your income to continue after your death. This choice is essential, especially if you have dependents or other financial obligations to consider.

Qualifying for Higher Income

Certain lifestyle and health choices can qualify you for a higher income through an enhanced annuity. Factors like alcohol consumption, weight, smoking, and various health conditions are taken into account. Declaring these characteristics can significantly impact your annuity income.

Transferring Pensions

Before transferring a pension, it's crucial to consider any associated fees, charges, or guarantees you might be giving up. Sometimes, the existing pension arrangement, such as a guaranteed annuity rate or defined benefit, might offer better terms than the open market.

Applying for an Annuity

Keep in mind that annuity quotes typically have a time restriction. You must finalise the application within the designated timeframe to lock in the quoted rate. Rates can fluctuate, so be sure to review your options carefully. Health and lifestyle factors can only be considered at the time of application, and once established, your annuity rate cannot be changed.

The Safety Net

In the unlikely event that your annuity provider goes out of business and cannot fulfil its commitments, the Financial Service Compensation Scheme serves as a safety net to protect your annuity income.

Exploring Alternatives

If a pension annuity doesn't align with your retirement goals, there are alternative income options, such as drawdown or taking lump sums from your pension. You can even combine different approaches to tailor your retirement income strategy to your needs. One common approach we see quite often is “flex then fix”, where people prefer the flexibility of income drawdown in their early retirement and then fix their income with an annuity later.

Seek Professional Advice

As you approach retirement, it's highly advisable to seek advice from a financial adviser. They can help you navigate the complexities of retirement planning, assess your individual circumstances, and recommend the best approach based on your goals and risk tolerance.

If you would like to talk to us about your options in retirement, feel free to give us a call on 0191 384 1008 or email us at Alternatively you can fill in our contact form here, and book in a time for a call-back with one of our advisers at a time that suits you.

Alternatively, if you would like to know more about annuities before getting in touch, you can watch our explainer video below.

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