Six Steps to purchasing an annuity
This section shows you six steps which are essential before purchasing your annuity.
- Consider your retirement objectives
- Consider whether you require the tax-free cash lump sum
- Consider which annuity options are the most suitable
- Check for guaranteed annuities from your existing provider
- Consider your State of Health
- Decide which annuity provider to use
Step 1: Consider your retirement objectives
a) When should you buy your annuity?
Annuity rates are difficult to predict, so postponing your annuity purchase in the hope that annuity rates will increase is difficult. Life Offices make regular adjustments to their rates- often changing them four or more times in any given month. All things being equal, annuity rates do improve with age. However, they are also determined by mortality rates and 15 year gilt yields. It is usually best to time taking out an annuity with changes in personal circumstances and your income needs.
b) How much income do you require from the annuity?
You need to consider your immediate and future income requirements and take into account all sources of income. It is important to consider the effects of inflation and you can index your annuity to keep pace with inflation, although this will reduce your initial income. Once set up an annuity cannot be changed later. If you require a considerable amount of flexibility and control, you may be better off with a Drawdown arrangement, which can always be annuitised later.
c) What is your attitude to risk?
It is essential that you consider your attitude to risk. Investment risk is a key risk factor, and a conventional annuity is guaranteed. However, if you are prepared to take some risk, you may wish to consider with profit or unit linked annuities, or alternatively, pension fund withdrawal.
There are also other risks other than investment risk which you may not have taken into account. There is the risk that inflation may erode the purchasing power of your annuity income- particularly if you live a long time and chose a level annuity. In addition, there is the risk that you or your spouse might die early into the contract- leaving a windfall for the Life Office.
d) What is the effect of taking out an annuity on your tax position?
You need to consider what the consequences of your annuity purchase are likely to be on your tax position. This is particularly the case as far as eligibility for Age Allowance is concerned- since this is means tested and reduces by £1 for every £2 by which you exceed it. If your annuity pushes you just over the bands on income where Age Allowance is reduced, potentially all the way down to your basic Personal Allowance, then your marginal rate of income tax, deducted at source, is very high. Income Drawdown can give you the necessary flexibility to ensure that you make the most of these allowances.
Step 2: Consider whether you require the tax-free cash lump sum
Most pensions now pay a lump sum of 25% of the value of the fund. You have the option to take the tax free cash and have it paid to you as a lump sum, or you could chose to annuitise this amount to enhance your income. Please bear in mind that the income paid from an annuity is taxable at source, whereas the tax free lump sum can always be invested in other income producing assets which may have more generous income tax treatment.
If you are amalgamating pensions from various sources, it may be batter to ask the receiving Life Office to pay the tax free cash lump sum, and to bring the funds across as a transfer, as opposed to an open market option (OMO) where the ceding schemes pay the tax free cash. This is because some Life Offices cannot merge more than one fund which has been brought across as an OMO. Since the size of the fund can have a bearing on the annuity rate produced, it is advantageous to merge the funds into one annuity policy. It is also easier to administer one annuity policy, as opposed to several.
Step 3: Consider which annuity options are the most suitable
You will need to decide on indexation options, spouse's benefits, guarantee periods and frequency of payments. Please refer to the Annuity Options page for a detailed explanation of these options.
Step 4: Check for guaranteed annuities from your existing provider
Many pensions were set up with a guaranteed annuity rate which was designed to protect the policyholder's income from falling below a certain amount if annuity rates fell. Since we are currently in a low interest rate economic cycle, most of these guarantees are more generous than rates obtainable on the open market. You can easily check to see whether your pension is subject to these guaranteed annuity rates by contacting your pension provider and asking them to clarify whether you have guaranteed annuities. If you are fortunate enough to have these guarantees attached, you would forego them by taking the open market option and purchasing the annuity with a different provider. As such, you need to compare the guaranteed annuity rate available with what is on offer from the open market. Please note that with guaranteed annuity rates there are often restrictions on the age at which you can take benefits and also the annuity options, such as spouse's benefit and indexation which you can add to the policy. You need to be aware of what these restrictions are and to consider whether they are acceptable.
Step 5: Consider your State of Health
If you have health issues which could reasonably be expected to reduce your life expectancy, then you need to consider taking out an "impaired life" annuity where the rates are more generous. If you are in good health, but your spouse is not, and you want to take out an annuity which would pay an income to your spouse even if you are not alive, you can still obtain a more generous annuity with an impaired life annuity.
Since impaired life annuities involve a process of medical underwriting and assessment, it is not as straightforward in comparing the rates on offer from the Life Offices. As such, it is often worthwhile making a multiple application to several Life Offices to obtain the best annuity rates. whilst this can be more time consuming than quoting for non impaired life annuities, it can make a significant difference to your retirement income. We can help you with this by asking you to complete one medical questionnaire form which we will then forward to several Impaired Life Annuity underwriting departments to see whether you will qualify for an uplift.
Step 6: Decide which annuity provider to use
It is important that you obtain the best annuity rate available by selecting the most generous annuity rate on the open market. The figures produced from our real time quotation engine are inclusive of our commission rebate, which is never less than 51%- even on small pensions. Prior to rebating commission, it is uplifted on institutional terms which reflects the volume of annuity business which we submit to the Life Offices.