Pension Annuities – A Guaranteed Income

What is a Pension Annuity?

Purchasing an annuity is just one of the options available to you in retirement. Before the pension freedoms changes in 2015, pension annuities were the most common form of pension income. Since then, the range of pension options, such as Flexi Access Drawdown, has increased substantially. Although annuities are less common, they are still appropriate in some instances.

When you buy your annuity, you effectively exchange the money on your pension pot for a guaranteed income. This income is paid for the rest of your life.

You can withdraw up to 25% of your pension fund as a lump sum, which is tax-free.

The balance can then be used to purchase an annuity. Most people can access their pension funds from age 55. Certain situations, such as your occupation or health, affect the age at which you can take benefits.

For example, if your pension fund is £500,000, you can take a tax-free lump sum of up to £125,000 when you turn 55. You can then use the leftover £375,000 to generate an annuity income.

The retirement income you receive will depend on several factors, including current rates, your age, health, lifestyle, and the type of annuity you choose.

It is worth taking the time to get financial advice. Your financial adviser can help you find the best provider. Keep in mind that annuity payments are considered taxable income.

An alternative is to contact the UK Pension Wise Service. This is a free government service. However, it cannot give you any advice. While Pension Wise can provide useful information about your retirement options, it does not offer personalized pension planning tips and advice. For tailored recommendations, consider seeking help from a qualified financial advisor who specializes in pensions. They can guide you in creating a strategy that aligns with your specific financial goals and retirement plans.

What does an Open Market Option mean?

An Open Market Option (OMO) lets pension holders compare the annuity rate from different providers. This means they do not have to accept the first offer from their pension scheme.

This may help you earn more money in retirement. Different providers may have different rates depending on your age and medical conditions, such as high blood pressure. They also adjust rates based on market conditions.

It’s an important consideration for anyone looking to maximize their retirement income through annuities.

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The Types of Annuities on offer

You may choose various pension options when you take out your annuity, which can affect the amount of income. These are summarised below:

• You may choose to purchase a joint annuity (rather than a single life annuity). This gives your spouse or partner income when you die.
• In most cases, the survivor’s income will be a certain percentage of your income. However, this can still be a significant advantage.
• Due to inflation, it is sensible to set your income to increase each year. The aim is to maintain the same purchasing power. This could either be in line with the current inflation rate, or you may set it to increase at a fixed rate.
• You may also prefer to choose an investment-linked annuity. These annuities involve an element of investment risk. Your income will vary each year depending on the performance of your chosen investments.
• Another example of an annuity that can decrease is a flexible annuity. You trigger the Money Purchase Annual Allowance (MPAA) with both types. This restricts future contributions to your pension to £4,000 per year. Contributions over this amount will be subject to an annual allowance charge. This effectively removes the tax relief you would benefit from when contributing.

Investment Linked Annuities

You may also prefer to choose an investment-linked annuity. These annuities involve an element of investment risk. Your income will vary each year depending on the performance of your chosen investments. Another example of an annuity that can decrease is a flexible annuity. You trigger the Money Purchase Annual Allowance (MPAA) with both types. This restricts future contributions to your pension to £4,000 per year. Contributions over this amount will be subject to an annual allowance charge. This effectively removes the tax relief you would benefit from when contributing.

Annuity Guaranteed Periods

With most providers, you will also have the opportunity to set an annuity guarantee period. This is the length of time your annuity will pay out even if you die after purchasing the plan. Most guarantee periods are 5 to 10 years. If you die after starting your annuity, your beneficiaries will continue to receive your income. This will happen until the guarantee period ends.

Please note that your decisions when setting up your annuity are fixed and can not be changed later.

Pension Annuity death benefits

These vary greatly depending on the type of annuity you select at the outset. It also depends on the age the annuitant dies. For example, the tax treatment on death before age 75 differs from death after 75.

If a survivor’s income from a joint annuity is low, it may be possible to convert it into a one-time payment.

The rules surrounding this vary. However, the maximum lump sum possible under this rule is £30,000. This is known as a ‘trivial commutation lump sum death benefit’.

When is an annuity suitable?

Purchasing an annuity will not be the best choice for everyone. Retirees have the option to use a combination of pension options. Annuity purchases do not need to be the only method of providing retirement income. Below are some of the main situations when an annuity might be recommended:

• Annuities offer a safe option for retirees who want to avoid investment risk. The income from annuities is guaranteed for life. Some people feel too anxious when investing due to the volatility involved. In this case, an annuity may be more suitable.
• You do not have to use your entire pension pot to cover essential expenses to buy an annuity.

Many retirees convert part of their pension to cover rent and bills.

• This leaves the remainder of your pension invested and spent on optional expenses like vacations or leisure activities.
• When buying later in retirement, one factor that affects your income is how much longer you are expected to live. Therefore, the older you are when you purchase your annuity, the higher your income will be. Some providers will not sell an annuity to those over age 75. However, the rate at this age will be significantly higher than at age 55.

For example, a healthy 75-year-old choosing a £75,000 annuity could get an annual income between £5,000 and £6,000.

This rate is significantly higher—more than twice as much—compared to what a 55-year-old would get.

• In certain circumstances, providers will give enhanced annuity rates to retirees due to their health and lifestyle. This means your income will be higher as you are not expected to live as long as the average person your age.

Do you need more information?

In summary, annuities can give you peace of mind when your biggest concern may be running out of money. There is such a thing as longevity risk, which is the danger of outliving your money, but this can be bypassed with an annuity. If you need Pension Advice, please do not hesitate to get in touch. One of our retirement planning experts can assist you in making the best choices.