SAGA — Doing things properly

You choose at the start how often you want your income to be payable. Most people choose monthly payments, but you can be paid quarterly, half–yearly or annually.

Payments made in advance start immediately, whereas payments in arrears start after the first month (or quarter, half–year or year as appropriate). With payments in arrears, you get more income than if you select payments to be made in advance.

Another choice, but only for those paid in arrears, is to have an annuity with or without proportion. When you die, an annuity with proportion will pay an amount that is proportionate to the period from the last payment until the date of death.

Inflation is an important factor when looking at a retirement income that could be payable for thirty years or more. Bearing this in mind, you can elect to have your annuity income increasing annually by a fixed percentage, which is normally about 3%. Alternatively, you could arrange for your income to reflect the Retail Price Index (RPI) so that it moves each year in line with inflation. Note that your income could fall if there is a period of deflation. Building in this protection against inflation is valuable, but it is expensive to provide due to the future levels of income payable. As an illustration of the reduced initial income, a man aged 60 opting now for an annual increase of 3% would be offered a 30% lower annuity than if he had opted for a level income for life (source: Openwork Market Solutions).

You can purchase an annuity that includes a guarantee that the pension would be paid for a guaranteed number of years (to your estate) even if you die within the guaranteed period. A guaranteed period may be attractive to you if you have financial dependants, but should not be seen as an alternative to a pension for your spouse or partner, because the payments stop after the guaranteed period. Typically, guarantee periods of five years are chosen. The maximum is 10 years.

The cost of including a guaranteed period, which is reflected by a reduction in the amount of the annuity payable, would depend upon the age at which the annuity is taken out. The younger you are the less it would cost as it is considered less likely that you will die in the short term.

You may want to include your spouse or partner in your annuity plans. Then, should you die, your spouse or partner could continue to receive an annuity income. You choose the level of income you would like your spouse or partner to have following your death – this can be anything from, say, 10% of your annuity income, up to the full amount of 100%. The higher the level of annuity income you would like your spouse or partner to receive, in the event of your death, the lower the level of income you will receive. Your spouse or partner’s age will have to be taken into consideration. The younger he or she is the lower your annuity income will be.

If your health or lifestyle is such that your life expectancy is reduced, for example because you have a heart condition or are a smoker, then you could receive a higher income from what is known as an ‘Impaired Life Annuity’. This also applies to certain occupations, and as you can only benefit, it does no harm to check. For example, a 59–year–old man with health problems could receive a rate 70% higher. Source: Openwork Market Solutions.

With a conventional annuity the income you will receive in retirement is determined at the time you take it out. This avoids any risk that the income could fall if, for example, there was a drop in the UK stock market in the future. However, it is possible to consider alternatives. These alternatives include annuities where you decide on your own investment strategy for your pension fund. Also there are unit linked and with profit annuities, where the pension fund is invested in assets managed by an insurance company or investment company. These investment options could provide an increase in the value of the fund in the future, and thereby provide a higher annuity income. However, there is the significant risk that the fund could decrease in value and the income be reduced. Such plans would not normally be considered suitable for those whose main source of income is derived from their annuity. Also, and as a guide, investment annuities generally have a minimum purchase of £50,000.

With a USP you can take up to the maximum tax–free lump sum from a personal pension and also from some money purchase company pension schemes where the rules have been amended to accommodate this option. The remainder of your pension fund is then reinvested in the hope that it will maintain its value or, perhaps, increase in value over the years. Because a USP fund is still considered to be a pension fund, growth would benefit from certain tax advantages.

From this reinvested USP fund you can draw an income each year. However, the HMRC is quite strict about the maximum amount of income you can draw each year, and how it is taxed. The income you take out of the fund can be varied to suit you, providing it is within limits set by the Government. You can continue to use the USP facility until you are 75, at which time you must convert any remaining money in your fund into an annuity, or opt for Alternatively Secured Pension (ASP), which is explained later. Also, as a guide USPs generally have a minimum purchase of £100,000.

As an alternative or an addition to a USP plan, you could consider a phased retirement plan. This is where your pension fund is divided into a number of individual segments – this could be as many as 1,000. Every year a certain number of these segments are withdrawn from your pension fund. These are used to provide you with some of the tax free cash to which you are automatically entitled, as well as money which, is used to purchase an annuity or invested in a USP plan which in turn, will provide an income in the future.

When you reach age 75, and have not bought a lifetime annuity, you must use any residual invested pension funds to purchase a lifetime annuity or enter into Alternatively Secured Pension (ASP). This operates in the same way as USP, but with some different rules:

• From April 2007, the minimum income you can withdraw for a level single–life lifetime annuity is 53% up to a maximum of 90% of the limit set by the government.
• This limit must be reviewed every year.
• Regardless of your actual age, the maximum income will be based on age 75.

The funds in ASP are invested in a similar way to a USP arrangement and are therefore subject to investment risk.

You will be able to convert your alternatively secured pension into a lifetime annuity at any time.