Contents: What is an Annuity?

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1 Contents: What is an Annuity? When might I need an annuity policy? Types of annuities Pension annuities Annuity income options Enhanced and Lifestyle annuities Impaired Life annuities Annuity rates FAQs Where can I go to get more help?

2 What is an Annuity An annuity is an agreement or contract, where a person or a company, usually a life insurance company (but it can also be a charity or a Trust) agrees to pay another person, the annuitant, a series of income payments. An annuity is purchased by the annuitant, either by: making regular instalments which are invested (known as a regular payment annuity) or with a lump sum (known as a single payment annuity). Annuities can be bought with savings or with a pension fund. Annuities are commonly used for retirement plans, (link to retirement planning booklet) as part of a retirement pension. There is usually a minimum fund size required required to buy an annuity. In very basic terms, an annuity is calculated by taking the amount of money you have invested (plus the interest) and dividing it by the number of years you are expected to live. Although annuities are purchased through a life insurance company, unlike life insurance, (link to life insurance booklet) an annuity does not require a physical examination and, instead of just paying out on death, the annuity is used to provide an income to the annuitant while they are still alive. An annuity that pays you an income for the rest of your life is called a life time or life annuity. In exchange for your pension fund (or other savings) the annuity company promises to pay you a regular income, which can be paid monthly, quarterly, halfyearly or annually, this income is taxable. When an annuity is purchased, the annuitant signs a contract which details the exact terms of the annuity, including the length of time that it covers, i.e. for the life of the annuitant or for a fixed number of years. A life annuity is a form of longevity insurance. When the annuitant dies or the fixed term ends the contract terminates and any remaining funds are forfeited, unless there are other annuitants or beneficiaries named in the contract. From April 2011, the UK Government will end the rule that means you have to buy an annuity with your pension savings when you reach the age of 75.

3 As a result of the Emergency Budget in June 2010, the UK government is phasing out the compulsory age limit for buying an annuity with your pension fund and introducing measures for people turning 75 before April 2011, who haven t yet bought an annuity. Because annuity policies and contracts are complicated it is always advisable to take independent financial advice or use the services of a qualified annuities adviser before purchasing an annuity. This booklet explains the different types of annuities to help you make more informed decisions in consultation with your adviser.

4 When might I need an annuity policy? In the UK, up until recently, it has been compulsory to convert at least 75% of your pension fund into an annuity when you reach age 75 (as at June 2010 the Government is currently planning to remove this age limit altogether). But even if you are under 75 there are still good reasons to have an annuity policy, especially if it's part of a retirement plan. If you are lucky enough to be gifted an annuity through a charity or trust then obviously the extra income will be beneficial whatever age you are! However, even if you are buying your annuity they are a good way to ensure a fixed and stable income when you stop working. Retirement annuities can also be set up to provide an income for two people, i.e. you and your partner or spouse. In addition to this annuities can be tailored to suit your personal needs, for example when setting up an annuity you can choose: whether the income stays the same throughout your lifetime or increases each year, to guarantee payments for a minimum period of time, such as five or ten years, even if you die within that period. whether the income ceases on your death or transfers on to a spouse, civilpartner or dependant. Buying an annuity is one of the few situations where being a smoker or having poor health can be an advantage when getting an insurance policy! If you smoke or are in poor health your life expectancy is likely to be shorter, therefore life insurance companies can afford to pay you higher annuity incomes, because they expect to pay it for a much shorter time, than for someone who doesn't smoke and is in good health. Based on the current UK population, the number of over 65s in the UK is set to swell by 60% to 15 million people in the next 20 years, and one of the biggest risks pensioners face in retirement is living too long and their savings running out. Buying an annuity can be a good way to ensure you have a retirement income for the rest of your life.

5 Types of annuities There are two types of annuity available in the UK, these are: Voluntary Purchase Annuities Compulsory Purchase Annuities (Pension Annuities) The main difference between voluntary and compulsory purchase annuities is voluntary purchase annuities are bought with personal savings (not pension scheme savings) or a capital lump sum, there are also tax differences. The capital lump sum used to buy a voluntary annuity can be the 25% tax free cash lump sum you are allowed to take from your pension fund. Compulsory purchase annuities are bought with pension funds as a requirement of HM Revenue & Customs. Everyone who has a private (non-state) pension scheme is expected to buy a compulsory annuity with at least 75% of their pension fund (allowing for 25% to be taken as a cash free lump sum). These are called pension or retirement annuities. Voluntary purchase annuities can offer an alternative to putting your savings into a bank or building society. Putting your savings into a bank account means you can earn interest and you get your full savings amount back from the Bank when you die or close the account. However, the amount of interest earned is affected by rising and falling interest rates. Using your savings to buy a voluntary annuity can provide a higher income than bank interest payments would, but you don't get your initial savings amount back if you die or when the annuity term ends. However, you are guaranteed a certain level of income which is not affected by rising or falling interest rates. A voluntary annuity can be a good option for people who don't need to have a lump sum left in the bank when they die, and want to use their savings to 'buy' an income to use while they are alive. It is always essential though to consider other investment options which also generate income, such as investment bonds, ISAs and some National Savings products, before taking out a voluntary purchase annuity.

6 The table below outlines the types of voluntary purchase annuities available in the UK: Voluntary Purchase Annuity Type How it works Also known as an Immediate Life Annuity, it pays a regular, guaranteed income for either: the rest of your life, or for a fixed period of between 2 and 20 years (temporary annuity). Purchased Life Annuity Taxed differently to pension annuities, income is made up of a 'capital' part and an 'interest' part. The capital part is treated as a return of your capital and is therefore not taxed. Similar annuity income options are available as for pension annuities. No age limit to buy, anyone of any age can have one. Minimum amount required to buy is around 5,000. Maximum investment amount around 500,000. Can also be known as an Immediate Life Annuity, it pays a regular, guaranteed income like a purchased life annuity but can be purchased from either: Immediate Vesting Annuity accumulated savings or a pension fund. Must be aged 55 years or older to purchase. Taxed differently to purchased life annuities. Provided you are over 55 and a UK resident, you are entitled to up to 720 in tax relief and an immediate tax free lump sum. For example, if you contribute 2,880 to an immediate vesting annuity, you receive 720 in tax relief, bringing the contribution amount up to 3,600. Of this, 25% is paid back to you in the form of a tax free lump sum of 900. The remainder of the fund goes to purchase the annuity.

7 Pension Annuities There is a large market in the UK for Pension Annuities, also known as Retirement Annuities. The table below outlines the most common types of UK pension annuities: Pension Annuity Type Single Lifetime Annuity Temporary/s hort term annuity Investment linked - Variable Investment linked - Unit Linked Investment linked - With profits Investment linked - Flexible Protected Rights Annuity How it works Also known as a conventional pension annuity. Purchased from a life insurance company with the proceeds from a pension fund and put into fixed investments. Provides secure, guaranteed, risk free income for the life of the annuitant, however long they live. The annuity policy stops when the annuitant dies with no further payouts. Also known as phased draw-down, works the same as a conventional pension annuity but you only use part of your pension fund to buy the annuity. Income is paid for a fixed period of of up to 5 years or up to age 75 whichever occurs first. Income payments can be level or increase each year at a fixed rate or in line with the Retail Price Index. Suits people who want to delay buying a lifetime annuity. A combined annuity which is partly a fixed conventional annuity and partly an investment linked annuity. Income is partially guaranteed with the possibility of increasing but not as secure as a conventional annuity. Flexible options as your needs and dependants needs change. A lifetime annuity but your pension fund is invested in units in investment funds, annuity income is linked directly to how well the funds you have invested in perform. You can usually choose the types of investment funds from: Medium-risk managed fund - broad range of various different shares and other investments to spread money and reduce risk. Higher-risk managed fund - various shares and other investments in a particular sector, such as smaller companies. Money is less widely spread so risk is higher. A tracker fund - closely follows the performance of a particular stock market related index. Usually has lower charges than managed funds. The more risky the underlying fund selected, the more income may vary, up and down. This is a medium to high risk annuity. Combines an income for life with investing in the stock market. Income can go up and down depending on investments selected, but this annuity guarantees income will never fall below a certain minimum level over the longer term. Investment growth can keep income higher than inflation. This annuity is low to medium risk, but more complex than other options. Provides an income for life but provides more flexibility and control over income, than other annuity options. For example, funds can stay invested in chosen investment funds until you are aged 80 years or over. Income is linked to performance of selected funds and isn t guaranteed. Annuity income in future years could be lower than the amounts at start. If you contract out of the Additional State pension, and put National Insurance (NI) rebates into a personal pension fund, you must use that part of that pension fund to buy a protected rights annuity. Your pension provider can tell you if protected rights applies to you and what it might mean in your circumstances. You will usually have to buy a joint-life annuity paying a 50% spouse s pension benefit if you are married or have a civil partner. You can choose between taking level annuity payments or an escalating income.

8 Annuity income options Most annuities come with options you can add to the annuity contract at an extra cost. It is important to note that, except for flexible annuities, these options usually can't be changed once they've been added to your annuity contract. Common options that can be included in an annuity include: Annuity option Joint Spouse/Dependent Level or Escalating payments Guaranteed Period Lump sum death benefit/capital protection Overlap What it offers A joint or dependent annuity continues to a named person when you die. The payments can remain at the same level or reduce to a previously nominated percentage, i.e. a third or a half of your payments. Income payments can remain the same, i.e. a fixed rate of 3% throughout the life of the annuity (level), or can be linked to the Retail Price Index to increase in line with inflation each year. A normal lifetime annuity stops as soon as you die, but if you select a guaranteed period of between 5 and 10 years your annuity is guaranteed to pay out for that period regardless of when you die. If you are alive at the end of the guaranteed period, the annuity continues to pay until you die at which point the annuity policy stops. This option guarantees a lump sum payout if you die before age 75. The payout is based on how much you've already received from the annuity, less any costs. These lump sum payouts are currently taxable at 35%. Available if you have taken both a joint annuity and guaranteed period option - it enables the annuity payments to transfer to your spouse and still receive the guaranteed payments if you die. Without this option your spouse would have to wait until the guaranteed period is over before starting to receive their annuity payments. Having additional options can significantly reduce the income you would get from your annuity, so take advice and ensure you select options carefully.

9 Enhanced and Lifestyle Annuities Generally annuity rates and income levels are based on your age, an assumption you are fit and healthy with a normal life expectancy, and more increasingly in the UK where you live, people who live in less affluent areas usually get higher annuity rates! However, people who are not fit and healthy or don't have a normal life expectancy due to medical reasons can benefit from a: Lifestyle Annuity Enhanced Annuity Impaired Life Annuity The income from these annuities is based on your health and/or lifestyle, and, unlike other annuities you will be asked for a report from your doctor to verify the details on your application form. If you are accepted for an enhanced annuity, your income will be higher than from a conventional annuity, sometimes as much as 40% higher, because the annuity provider expects to pay your income for a shorter period of time. This can make a substantial difference so always take advice to ensure you are offered the right type of annuity for your personal circumstances. A lifestyle annuity takes into account environmental, behavioural and medical factors (which may include smoking over a long period, obesity, high blood pressure, etc). An enhanced annuity pays more than a lifestyle annuity, because as well as being available for regular smokers, and people who are overweight, it may also cover you if you have spent most of your working life in a hazardous occupation, such as mining. The Pensions Advisory Service gives the following list of providers who offer enhanced annuities: Aviva AXA Canada Life Just Retirement Legal & General LV= MGM Advantage Partnership Prudential Reliance Mutual Scottish Widows Note: These providers will only accept business through an Independent Financial Adviser.

10 Impaired Life Annuities An impaired life annuity pays an income for life like conventional annuities, but it is specifically for people who have a medical condition which severely reduces their life expectancy, including, but not limited to: high blood pressure diabetes heart conditions kidney failure certain types of cancer multiple sclerosis chronic asthma The income from these annuities is mainly based on your medical condition and life expectancy, so unlike other annuities you will be asked for a report from your doctor to verify the details on your application form. If you are accepted for an impaired life annuity, your income will be higher than from a conventional annuity because the annuity provider expects to pay your income for a shorter period of time. This can make a substantial difference so always take advice to ensure you are offered the right type of annuity for your personal circumstances. The Pensions Advisory Service gives the following list of providers who offer impaired life annuities: Aviva Canada Life Just Retirement Legal & General LV= MGM Advantage Partnership Prudential Note: These providers will only accept business through an Independent Financial Adviser.

11 Annuity rates Annuity rates are set by insurance companies selling annuities, in the same way Banks offer different savings rates. Annuity rates are reviewed frequently and go up and down making it difficult to determine when it's a good time to buy an annuity. An annuity rate is what is used to convert a pension fund or lump sum into an annuity, for example: Value of fund x Annuity rate = Annuity The actual amount of income obtained from an annuity is dependent on several factors including the size of the fund used to buy the annuity, the annuity rate used and the type of annuity purchased. With a retirement annuity, the annuity is either purchased on your behalf by your pension provider or you can take what's called an open market option (OMO) which involves searching the market place for the best annuity rate. A pension provider that has been investing a fund on your behalf may not always be in a position to offer the best annuity rates. Some types of pensions don't qualify for an open market option but if yours does, taking advantage of the open market option can increase your annuity income by as much as 15% to 30%. However, your pension may include a guaranteed annuity rate (GAR) which may be better than current open market rates so always check this first. If you have a pension fund of less than 10,000, you may be limited by the number of annuity providers who will accept your fund. Because some annuity rates can be linked to inflation, your annuity payments might be reduced if inflation falls below zero, unless you take out a guarantee against negative inflation at the start. This guarantee has a cost and can reduce your starting level of income. Buying an annuity is a financial commitment which can't be altered once you have entered into an annuity contract. Getting the right annuity for your needs is very important so wherever possible take the advice of an Independent Financial Adviser.

12 Always ask for a Key Features document from annuity providers or from your financial adviser, these documents will provide important information about the annuity including: The annuity rate The type of annuity being offered, i.e. a fixed term or lifetime annuity How and when you will receive the annuity income Annuity charges What any dependents may get if you die You can take advantage of independent online comparison sites that compare annuity rates from different providers. It's important to take your time to compare as many providers as possible to make sure you understand what's available. We've included some links below to respected independent comparison sites to help start your research: - Best annuity rates from some of the leading UK annuity providers. Specialist quote facility if you have ill health and qualify for higher annuity rates. - Find and compare the best annuities. - Compare Annuities: Life Annuity, Pension Annuity, Retirement Annuity and Fixed Annuity

13 Frequently asked questions Here are some frequently asked questions and their answers which may also assist: What is a Guaranteed Annuity Rate (GAR)? A Guaranteed Annuity Rate (GAR) provides a fixed rate for converting a pension fund into an income at retirement. It is written into the policy conditions of your pension and does not alter with changing investment conditions. The rates are usually more generous than those available on the open market. They may, however, have conditions that limit the way your annuity is paid, e.g. often there is no provision for annual pension increases or for a pension payable to your spouse upon your death. What is a Retirement Annuity Contract (RAC)? Retirement Annuity Contracts (RACs) are a type of pension plan that individuals could take out up until 1 July 1988, when the current form of Personal Pension Plan (PPP) was introduced in the UK. Retirement Annuity Contracts were available to those in employment where there was no access to an occupational scheme and to those in self-employment, provided they had earnings subject to UK taxation. After 1 July 1988, no new Retirement Annuity Contracts could be taken out but those with existing contracts were able to continue to contribute to them. While the new personal pension plans were designed on similar lines to Retirement Annuity Contracts, there were some areas in which they differed. Retirement Annuity Contracts were allowed to retain some features that did not apply to Personal Pension Plans. From 6 April 2006, under new rules introduced by HM Revenue & Customs, Retirement Annuity Contracts were put on the same basis as Personal Pension Plans and almost all of their special features no longer apply. Why would I need to include the option of a Guarantee Period in my pension annuity? If an annuity is guaranteed for a specified period, it is guaranteed to be paid for that period, regardless of when you die. For example, if you bought an annuity today, with no guarantee period, and died shortly afterwards, the money you used to buy the annuity is gone, and your estate would receive nothing. But if a guarantee period is in place, your estate continues receiving the annuity pension payments for the remainder of the guaranteed period. Is 'Income Drawdown' the same as buying an annuity? Income drawdown is an alternative option instead of buying a lifetime annuity when you reach retirement. Income drawdown is also known as an unsecured pension. Income drawdown is an arrangement that enables you to start drawing an income from your pension fund while the fund remains invested. It is usually something done with larger pension funds of around 100,000 or more, and for people who have other assets.

14 How are annuity rates calculated? Annuity rates are calculated by actuaries (financial experts who use statistics to calculate insurance premiums). They use several factors such as: mortality rates interest rates age gender health (in some cases) Generally, the older a person is the higher their annuity rate because their life expectancy is shorter than a younger person. Men also get higher annuity rates than women of the same age because men statistically have a lower life expectancy.

15 Where can I go to get more help? The following links may also provide additional help and information: The Consumer Finance Education Body (CFEB) has annuity rate comparison tables on their Moneymadeclear website showing providers currently offering the best annuity rates and how much you could receive. The Pensions Advisory Service (TPAS), is an independent voluntary organisation, grant-aided by the Department for Work and Pensions (DWP). They provide information and guidance on all pension matters, including state, company, personal and stakeholder schemes. They can also help if you have a problem, complaint or dispute with your occupational or private pension arrangement. Reputable annuity providers should be a member of the Financial Services Association (FSA). Check the FSA register at to see whether your provider is registered and regulated by the FSA. An Independent Financial Adviser (IFA) may be able to assist you in comparing and purchasing annuities. You can find a number of IFAs in you local area by using