What is an annuity?

26 January 2015

The rules on how people take their pensions are being overhauled significantly in 2015. One of the biggest changes applies to annuities, which until now have been the most common way for savers to turn their pension funds into an income in retirement.



What is an annuity?

An annuity is a financial product sold by an insurance company which guarantees to pay the holder a certain amount of money every month for the rest of their life.

How much will the annuity pay?

This depends on a number of factors, including how much money is in your pension pot, how old you are when you buy your annuity, what annuity rates in general are like when you buy it, and what the state of your health is.

What is happening to the rules around annuities?

Until April 2015, most people had to use their pension funds to generate an income for their retirement. In the majority of cases, this meant buying an annuity.

But changes in the law mean that there is no longer the obligation to generate an income from your pension fund.

Why have annuities been criticised?

Increasing longevity and falling interest rates since the financial crisis of 2008 mean that annuities over the past few years have paid out less than in the past.

Another issue is that an annuity contract is generally irreversible: once you have bought one, you cannot cash it in or try to get a better rate. You need to be certain that a secure income in retirement in exchange for your pension funds is your preferred option.

A lot of annuity customers have also automatically taken the annuity on offer from the provider of their pension fund, who may not always provide the best income. If opting for an annuity it always pays to shop around to see whether another annuity provider may offer a better rate, especially if you are in poor health.

Do annuities have anything to recommend them?

Despite these issues, buying an annuity could still be the right thing to do in many circumstances.

They offer a guaranteed income which will not fall if, say, the stock market plunges. For those who wish to take no risk with their retirement income and want certainty over the level of income they will receive, an annuity may still be the best option.

The 2015 law changes mean that more people are likely to keep their pensions invested after they retire, or buy assets such as buy-to-let property: but though these options give greater flexibility and potentially better death benefits, there is a risk of losing money.

Also, an annuity means you will never run out of money: if you take an income from investments, there is a chance you will exhaust your fund before you die.

What kinds of annuities are available?

There are numerous types of annuity, and which one will suit you best depends on your personal circumstances.

Index-linked or escalating annuities

These pay an increasing amount of money every year in line with inflation or by a fixed percentage. The trade-off is that in the early years they pay less than level annuities, where the income stays flat for the rest of your life.

Joint-life annuities

These are aimed at couples. The annuity will continue to pay out after the first partner dies, unlike single-life annuities. From April 2015, it will be possible for a joint life annuity to be paid to anyone, rather than specifically to a spouse or financial dependant.

Enhanced annuities

This type is for people who have health conditions, such as heart disease, diabetes or high-blood pressure, which could reduce their life expectancy. Enhanced annuities pay higher income than normal annuities. Some lifestyle choices such as smoking may also give an increased rate.

 

If you are interested in knowing what level of income you may receive from an annuity contact the Saga Annuity Service for a quote.

 

The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.