Annuities contain a wide range of options which include indexation, spouse's benefits and guarantees of the annuity being paid for a fixed period of time from vesting, up to 10 years, regardless of whether the annuitant lives or dies. Each added option will cost more and consequently will result in a decrease in initial income compared to a "standard" annuity. If you opt for an annuity which contains a spouse's pension and your spouse dies the day after annuity purchase, you cannot unravel the widow's benefits which, with hindsight, were unnecessary.
Annuity Guarantee Periods
You can select an annuity which is guaranteed to be paid for five or ten years from the date of vesting, even if you die before then.
A guaranteed annuity is an annuity which is guaranteed to be payable for a minimum period regardless of when the annuitant dies. As an example, an annuity guaranteed for 10 years will pay a minimum of 10 years from the date the annuity is purchased, even if the annuitant dies during this period. If the annuitant survives after the 10 year guarantee date, income will continue to be payable throughout their lifetime.
The origin and type of annuity will determine its treatment on death. If the annuity is outside its guarantee period, no further payments or lump sum will be paid. If the annuity is on a single life basis and still within its guarantee period, a proportionate amount is paid to the client's estate which will be taxed as income.
If the guarantee period is five years or less and the annuity originates from an occupational scheme, the outstanding guaranteed annuity will be paid as a lump sum. If the guarantee period is for more than five years, an income not a lump sum will be paid.
If the annuity includes provision for a spouse, then on the death of the first annuitant, the annuity will continue (although not always in full) to the second life until their death, at which point no further payments will be made.
Joint Life Annuities
If you are married or in a civil partnership, you may want to select a joint life annuity where payments would continue to the surviving partner for the rest of their lives. You can chose to have these payments continue at the same level as when the annuitant was alive, or you can select to have them reduce by a third or a half.
If you have protected rights (from contracting out of SERPS or the State Second Pension) and are married, separated or in a civil partnership, a 50% spouse's income for your protected rights must be chosen.
Annuities which increase in line with the Retail Prices Index, or at a fixed percentage amount each year, can be selected from outset. If you want to maximise your initial income, selecting a level based annuity will do so by about one third, but you will be at risk of having your spending power eroded by the effects of inflation. With people living longer, the effects of inflation can be considerable, even within a low inflationary economic cycle.
A person retiring on a fixed income would probably find the value of that income reducing in real terms gradually over a period of time. The effect of inflation should therefore always be considered. It is possible to purchase an annuity where the installments increase by a fixed percentage each year, or to choose an index-linked annuity, this means that the pension is guaranteed to rise in line with movements in a specified index, commonly the Retail Prices Index. Annuities can also be indexed in line with Limited Prices Indexation (LPI) which is RPI capped at 5% per annum.
Life Style Annuities
Life Style Annuities are increasing in popularity. By opting for such an annuity the individual can expect an income that will take into account certain factors surrounding their lifestyle and background which could affect their life expectancy. For example, an office worker may be expected to live longer than a coal miner all their life. A non-smoker would be expected to live longer than a smoker. Income levels will therefore be altered accordingly.
Each option that is added will have the effect of reducing the initial income payable to the annuitant. The table below shows the amount of income paid if various options are added. These have the effect of reducing the income as follows:
|Annuity Options added||Reduction in initial income|
|Five year guarantee||1.7%|
|Five year guarantee and 3% escalation||21.7%|
|Five year guarantee and 5% escalation||34.4%|
|Five year guarantee and 8.5% escalation||54.6%|
|Five year guarantee and a 50% spouse's pension||12.1%|
|Five year guarantee, 3% escalation and a 50% spouse's pension||32.3%||Five year guarantee, 5% escalation and a 50% spouse's pension||44.9%|
|No guarantee, indexation with RPI||33.82%||No guarantee, 50% Spouse's pension||10.83%|
|No guarantee, 100% Spouse's pension||18.44%|
Value Protection Annuities
Value Protection Annuities allow a pensioner to be sure they will always receive at least the value of the premium they paid to purchase the annuity, whatever happens to them. One of the most frequently expressed concerns about annuities is that the annuitant does not seem to get value for money if they die early in the term. Despite the fact that life expectancy is increasing dramatically and that studies have shown annuities represent a good combination of value and security, this still appears to be a significant concern and Value Protection is a way of addressing this concern. Many people like the idea that they can arrange to leave some money to someone on their death. Click here for more on Value Protection Annuities.