Annuities - making the most of your hard-earned savings

Money

Pensions

Annuities - making the most of your hard-earned savings

Boosting income at retirement is paramount with everyone living longer and the cost of living escalating, writes Holly Thomas

When your pension matures, you will have an important decision to make – choosing which annuity to buy.

The annuity converts your pension pot into regular income, for life. You only get to choose it once, and it cannot be switched at a later date if you think you made a mistake.

There are hundreds of different annuities available from pension providers in the UK, and you can choose one from any company, regardless of where your pension is saved.

It is a complex business, which means it's very important to get professional advice to help you make the right decision.

One of the most complex questions is whether to go for a level income that remains the same for the rest of your life, or one that rises every year in line with retail prices to protect you from inflation.

The decision would appear to be an easy one since inflation is a major threat to pensioners, and knowing that your annuity will keep pace with inflation provides peace of mind.

By contrast, a level annuity virtually guarantees that your standard of living will fall steadily over time.

But the decision is actually more complicated than you might think.

Yet, in choosing an escalating annuity, that rises in line with the retail price index (RPI), income in the early years is drastically reduced compared to the income taken from a level annuity.

Depending on the size of the pension pot, and annuity rates and so on, it could take many years before the escalating annuity starts to pay out more than the level annuity.

The longer you live, the better value an escalating annuity is. Not everyone has that time. If you are in poor health, a smoker or overweight, you will probably be better off with a level annuity.

If you have a small pension pot you will probably need to generate the maximum possible income, so you will have to go for a level annuity.

If you are married, you should consider a joint life annuity, instead of single life, although these come at a cost.

If you do not keep good health, you may be able to get what is called an enhanced annuity if you have a medical condition such as diabetes, a heart condition or cancer. It is also possible to get enhanced rates for increasingly common conditions such as high blood pressure, high cholesterol and type 2 diabetes.

It comes back to the fact that an annuity is, in effect, a bet with an insurer. The shorter the company thinks your life expectancy is, the higher the annuity payout will be.

Around four out of 10 people are entitled to an enhanced annuity, and with the average 65-year-old man having a life expectancy of 21 years, the extra amount each month can run into thousands.

All these scenarios need to be weighed up according to each individual situation. You should consider taking independent financial advice in order to make an informed choice and make the most of your hard-earned savings.

Written by Holly Thomas. The opinions in this article, published on November 26, 2009, are Holly's own and for general information only. Always seek independent financial advice.