What is an Annuity?
An annuity is essentially an insurance policy that pays you regular income in exchange for a lump sum. This lump sum will usually be the sum of the pension pot that you have worked hard to build up over the years.
You are not allowed to withdraw the funds in the pension pot you have built up in its entirety (although you are usually allowed to withdraw up to 25% of your pension pot as a tax-free lump sum at the age of 55 depending on the terms of your individual pension policy). You will need to use the remainder of the funds to purchase an annuity by the time you reach 75.
It’s essential that you choose the best possible deal when deciding on your annuity as conventional annuities cannot be changed once they have been chosen. Remember that you do not have to choose the annuity offering from your existing pension provider. The annuity market is a competitive one and you will certainly want to use your right to the ‘open market option’. You may be able to obtain up to 40% more income from your annuity by shopping around, so ensure you examine your options by speaking to an independent financial advisor.
Factors That Will Affect Your Annuity Rate
The amount you have saved into your pension pot over the years.
You may qualify for an enhanced annuity if you are in poor health. If your annuity provider expects a shorter life expectancy, it may offer you a better annuity rate as it expects to pay out for a shorter period.
Some annuity providers will take into account where you live. If you live in an area with low mortality rates, you may be offered a higher rate.
Interest rates will influence what insurers are willing to offer you with regards to your annuity rate as they affect the value of bonds which they buy to fund annuities.
Benefits of Annuities
You can expect a fixed regular income from the day you purchase your annuity until the day you die with no hidden surprises. This can help you plan your lifestyle with peace of mind that you know the income you can expect to receive for the rest of your life.
You have the option to choose the annuity that best suits your requirements such as one that continues to pay your spouse after you die.
Downside with Annuities
You need to ensure that the annuity you purchase is the best one for your requirements because once you have decided, there is no going back. That’s why you need to obtain financial advice so you are armed with all the facts before you decide which annuity to choose.
Alternatives to Annuities
Since April 2011, you are able to opt for an Income Drawdown as opposed to an annuity. This allows you to take income directly from your pension while leaving it invested. Income drawdown is usually only a realistic option for those with a large pension pot as you need to make significant gains each year to obtain the same sort of income that you would get from an annuity.