Guide to Buying a Pension Annuity

Transcription

1 Guide to Buying a Pension Annuity

2 Contents Introduction Pension Annuities 02 What is an Annuity? 02 Who Needs to Buy an Annuity? 02 Who Doesn t Need to Buy an Annuity? 02 Where Do You Buy an Annuity? 03 When Can You Buy an Annuity? 03 I m Ready to Buy an Annuity Now Where Do I Start? Simple Steps 04 Step 1 Read Through the Paperwork. 04 Step 2 Tax-Free Lump Sum. 04 Step 3 Level Annuities or Increasing Annuities. 05 Step 4 Single Life or Joint Life Annuities. 06 Step 5 Guaranteed Annuities. 07 Step 6 Impaired Life and Enhanced Annuities. 08 Step 7 Use the Open Market Option Further Information and Checklist 10 What Can I do With a Really Small Pension Pot? 10 Do I Pay Tax on the Income I Get From an Annuity? 10 What Are Protected Rights? 10 Other Types of Annuity. 11 Alternatives to Buying an Annuity. 11 Choosing a Financial Adviser. 11 Paying for Financial Advice: Fees or Commission? 12 Key Points About Annuities. 12 Your Annuity Checklist. 13

3 Pensions Guide to Buying a Pension Annuity Introduction 1 Introduction Buying an annuity turns your pension savings into a regular income that you ll receive for the rest of your life. It s one of the most important transactions you ll ever make in your life so it s crucial that you choose an annuity that is right for you and that you shop around to make sure you get the very best deal that you can. This guide will help you to decide what kind of annuity is right for you and how to go about shopping around to make sure you receive the highest income you can in exchange for your pension savings. Please be aware that this is a rough guide only. Usdaw cannot provide you with financial advice. We strongly recommend that you seek professional independent financial advice when it comes to buying an annuity.

4 2 1 Pension Annuities What is an Annuity? An annuity is a financial product which provides you with an income for the rest of your life in exchange for your pension savings (often called your pension pot ). When you are ready to retire, you must convert your pension pot into a regular income payable to you for the rest of your life in other words you need to buy an annuity. Who Needs to Buy an Annuity? Anybody who has paid money into a Defined Contribution pension scheme during their working life will need to convert the value of their pension pot (or pension pots) into a regular income when they are ready to retire. The most popular way of doing this is to buy an annuity. You may need to buy an annuity on retirement if any of the following apply to you: You paid into a Personal or Stakeholder Pension either one you took out yourself or one provided for you by your employer. You paid into your employer s Defined Contribution pension scheme. You were divorced and your share of your ex spouse/partner s pension was paid into a Personal Pension specially set up to receive the money. You paid Additional Voluntary Contributions on top of your regular contribution to your employer s pension scheme. You took out a Personal Pension for the purpose of contracting out of the Additional State Pension (SERPS/State Second Pension) and your National Insurance rebates were paid into it. Who Doesn t Need to Buy an Annuity? If you worked at a company which had a Defined Benefit pension scheme (like a final salary or career average salary scheme) and you were a member of that scheme then you don t need to buy an annuity. Instead, your pension will be paid to you directly from the pension fund and worked out based on your salary and length of service. Some companies have Defined Contribution schemes which will make the arrangements to convert your pension pot into an annuity for you so you don t have to do anything. You should check with your employer s pensions department if you think this might apply to you.

5 Pensions Guide to Buying a Pension Annuity Section 1 Pension Annuities 3 Where Do You Buy an Annuity? Insurance companies sell annuities and set annuity rates that is the amount of income that they are prepared to pay you in exchange for your pension pot. Annuity rates change on an almost daily basis and can be influenced by a number of different factors. These are just a few: Interest rates annuity rates are less generous at times when interest rates are low and become more generous at times when interest rates are higher. Life expectancy how much income an insurance company is prepared to pay you depends on how long they think you are going to live for (in other words how long they are going to be paying you for). Where you live insurance companies can determine how long they expect you to live by your post code. People who live in low income areas are likely to get a better annuity than people who live in higher income areas. Your health and lifestyle smokers may get a better annuity than non-smokers and people with serious health problems may also be offered a better rate (see page 8). Your age naturally the younger you are when you choose to buy an annuity then the longer it is expected to be paid to you, which is going to result in a lower rate. When Can You Buy an Annuity? The minimum age that you are allowed to start drawing your pension savings is age 55 although in some cases, such as permanent ill health, you may be able to start drawing your pension savings earlier. I m Ready to Buy an Annuity Now Where Do I Start? If you are ready to start drawing your pension savings then the first step is to contact your pension provider. If it is a Personal or Stakeholder Pension then the provider is likely to be an insurance company, bank or building society. If it is a company pension scheme then contact the company s pensions department. Tell them that you want to start drawing your pension savings and ask them to send you a retirement quote. Allow at least three months between the date you contact your pension provider and the date you want your pension to begin. If yours is a company pension then starting to draw your pension savings does not necessarily mean that you have to stop working. Check with your employer to see what their policy is on this.

6 4 2 7 Simple Steps Step 1 Read Through the Paperwork Your pension provider will send you details of your options which might appear to be very complicated at first. Read the paperwork that you have been sent thoroughly and then follow these steps to help you choose the kind of annuity that is right for you. Step 2 Tax-Free Lump Sum Your first decision is whether you want to take part of your pension pot as a tax-free lump sum and how much. Current tax laws allow you to take up to a quarter of your pension pot as a tax-free lump sum. So if your pension pot is worth 20,000 then you can take any amount between 0 and 5,000 as tax-free lump sum. What s left of your pension pot after you ve taken away any tax-free lump sum must be used to provide you with a regular income. Step 3 Level Annuities or Increasing Annuities Level annuities are so called because they do not increase between the date they start and the date they end. They are popular because they offer the highest starting amount of income. The downside is that they can leave you vulnerable to inflation as the years go by. As household bills and shop prices rise, the amount of income you get from your annuity stays the same which means that the buying power of your annuity is being reduced every year by inflation. Increasing or Escalating annuities offer you some protection against inflation but the trade off is that you will have to accept a lower starting income than you get with a level annuity. Although your income increases every year it might be many years before an increasing annuity catches up with the starting amount of income you get from a level annuity. Once you ve decided how much tax-free lump sum you want then you know how much money you have to buy your annuity with. The next steps are to decide what type of annuity is right for you.

7 Pensions Guide to Buying a Pension Annuity Section 2 7 Simple Steps 5 To help you make your decision, ask yourself the following questions: Do you want to maximise your income in the earliest, healthiest and most active years of your retirement? If yes then a level annuity might suit you best. Would you prefer to maintain your buying power throughout your retirement? If so, then an increasing annuity will be more appropriate. If you choose an increasing annuity, you must also decide how much you want it to increase by each year. You will normally be given the following options: An annuity that increases by a fixed rate usually 3% a year. Or an annuity that increases in line with price inflation. So if inflation is 4% one year then your annuity will increase by 4%. If inflation is zero (or less than zero) then your annuity won t increase at all. Because inflation is hard to predict, an inflation-linked annuity usually offers a lower starting amount of income than an annuity that increases by a fixed rate. Example The following is the example of a 65 year old man buying a single life annuity with a 25,000 pension pot. Level or increasing annuity Level Starting income 1,548 a year ( 129 a month) Increasing by 1,092 a year 3% a year ( 91 a month) Increasing in line with inflation (RPI) 960 a year ( 80 a month)

8 6 Step 4 Single Life or Joint Life Annuities Now you should decide if you want an annuity that covers just you or one that protects your spouse or partner as well. A single life annuity pays you an income until you die. If you have a spouse/partner and you die before them, nothing will be paid to them which might leave them short of money. A joint life annuity will pay some or all of your income to your spouse/partner after you die. That income will continue to be paid to your spouse/partner until they die. The rates available for joint life annuities are lower than they are for single life annuities because the income may continue to be paid after you die. To help you make your decision, ask yourself the following questions: If you choose a joint life annuity you must also decide how much of your income you want to be paid to your spouse/partner if you die before them. You will normally have the following options: One half of your annuity. Two thirds. 100%. The greater the amount of income you want to be paid to your spouse/partner after you die then the lower the annuity rate will be. Example The following is the example of a 65 year old man buying a level annuity with a 25,000 pension pot. His spouse/partner is also 65. Do you have a spouse/partner? If not then a single life annuity will suit you better. Is your spouse/partner a lot older than you or are they in very poor health? If your spouse/partner is likely to die before you then a single life annuity might suit you better. Is your spouse/partner younger than you or in much better health than you? A joint life annuity might be more appropriate but the younger your spouse/partner is the lower the annuity rate is going to be. Does your spouse/partner have enough savings of their own to stay financially secure if you die before them? If they do then a single life annuity is best. If not then a joint life annuity might be better. Level of spouse/partners pension income No spouse/partner s pension (0%) Half (50%) Two-thirds (66%) The same as your annunity income (100%) Starting income 1,452 a year ( 121 a month) 1,308 a year ( 109 a month) 1,260 a year ( 105 a month) 1,176 a year ( 98 a month)

9 Pensions Guide to Buying a Pension Annuity Section 2 7 Simple Steps 7 Step 5 Guaranteed Annuities When an annuity has a guarantee period the income will be paid for a fixed period usually five or ten years even if you die during that time. If you die before the end of the guarantee period the remaining income due will be paid to your estate either in instalments or as a single lump sum. A guarantee period offers some protection to your spouse/partner if you die in the early years of your retirement but not as much protection as a joint life annuity. Having a guarantee period usually only makes a small difference to the annuity rate you ll be offered. Example The following is the example of a 60 year-old woman buying a level, single life annuity with a 20,000 pension pot. Length of guarantee period None Starting income 948 a year ( 79 a month) 5 years 936 a year ( 78 a month) 10 years 936 a year ( 78 a month) As you can see, adding a guarantee period to your annuity comes at a relatively small cost in terms of the reduction to your starting income.

10 8 Step 6 Impaired Life and Enhanced Annuities Annuity rates are linked to how long you are expected to live (in other words how long the income is going to be paid for). Some insurance companies will offer a better rate if you have health problems that are expected to shorten your life. These are called either Impaired Life or Enhanced annuities. You may be offered an improved annuity rate if any of the following apply to you: You are a smoker. You take regular medication. You suffer from chronic asthma. You have high blood pressure. You have recently undergone medical surgery. You suffer from diabetes. You have suffered a serious illness such as cancer, stroke or multiple sclerosis. Make sure that you make any health problems known when you ask for an annuity quote and find out if you qualify for an Enhanced or Impaired Life annuity. Some insurance companies offer them some don t. Some annuity providers offer smokers only rates, which also offer a higher level of pension income. Example The following is the example of a 65 year-old man buying a level, single life annuity with a 30,000 pension pot. Smoker or Non Smoker Non Smokers Smokers only Starting income 1,740 a year ( 145 a month) 1,980 a year ( 165 a month)

11 Pensions Guide to Buying a Pension Annuity Section 2 7 Simple Steps 9 Step 7 Use the Open Market Option This is potentially the most important factor in deciding how much income you will get in exchange for your pension pot. Anybody with an individual pension pot of their own (or if you have several individual pension pots) has a right to something called the Open Market Option. What this means is that if you saved up a pension pot with, for example, the ABC Insurance Company you don t have to accept the annuity quote offered to you by ABC when you retire. Instead, you can shop around and maybe buy an annuity from a different insurance company who might offer you a better rate. Taking your time to shop around for your annuity is proven to boost people s retirement incomes by 10% or more. This figure can rise to more than 30% if you are eligible for an Enhanced annuity. Despite this, only a minority of people use their Open Market Option. The reason why might be that people haven t been told about it or because they don t know how to use it. Although we re used to shopping around for the best deals on car insurance or household goods, too many of us don t take the time to shop around for the best deal on our annuity even though we will be relying on this money to provide us with an income for the whole of our retirement. A good place to start A good place to start is to go online and check out the annuity comparison tables on the website of the Money Advice Service. The Money Advice Service is a free, impartial advice service set up by the Government. Their web address is: Click on Comparison tables, then Compare annuities and answer the 10 simple questions about yourself and the type of annuity you want and you will be given a list of the annuity rates being offered by a handful of the biggest insurance companies. If one of these companies is offering a better rate than your own pension provider then telephone them and ask for a proper quote. The Money Advice Service website doesn t show all the annuity sellers on the market and there may be even better deals available out there. For a more thorough search of the annuity market Usdaw recommends that you seek professional independent financial advice (see the section of this guide called Choosing a financial adviser ).

12 10 3 Further Information What Can I do With a Really Small Pension Pot? On retirement, you may have a pension pot that is so small that your pension provider will only offer a very small annuity and you will struggle to find another provider willing to give you an alternative quote. For example, the Money Advice Service website generally won t generate annuity quotes for a pension pot which is smaller than 5,000 after any tax-free lump sum has been taken off. In cases like this, it can sometimes make more sense for you to take your pot as a single lump sum payment. This is called trivial commutation and there are strict rules surrounding it: You must be 60 or older to trivially commute a small pension pot. and The value of all of your pension savings (not including your state pension) must add up to less than 18,000 (in 2012). The first 25% of your trivial commutation lump sum is tax free. Tax will be deducted from the rest of the lump sum usually at the basic rate of income tax. You may be eligible to reclaim some or all of the tax deducted from the lump sum if you contact your local tax office after the payment has been made. A separate rule allows you to take up to two pension pots as trivial commutation lump sums as long as you are over 60 and each pension pot is worth less than 2,000. Do I Pay Tax on the Income I Get From an Annuity? Yes. The income you receive from your annuity is taxable at the rate of income tax which applies to you. What are Protected Rights? From 1988 onwards, people were allowed to contract out of the Additional State Pension (also called SERPS) through a Personal Pension taken out with a bank or insurance company. If you did this then the National Insurance office would have paid regular NI rebates into your pension pot. The money from those NI rebates was ringfenced by your pension provider and referred to as Protected Rights. Strict rules used to apply to Protected Rights. For example, you didn t used to be allowed to take any of your Protected Rights as tax-free lump sum. From April 2012 though the last of the rules applying to Protected Rights were removed and they can now be treated the same as all the other monies in your pension pot. Also, it is now no longer possible to contract out of the Additional State Pension via a Personal Pension. If you were still contracted out as of April 2012 then you will have been automatically contracted back in and the NI rebates will have stopped being paid into your pension pot.

13 Pensions Guide to Buying a Pension Annuity Section 3 Further Information 11 Other Types of Annuity There are other types of annuities which may or may not be suitable for you. For example Value Protected Annuities will return the value of your pension fund (minus any income you have already received) if you die before you are 75. There are also investment-linked annuities, with-profits annuities, unit-linked annuities and purchased life annuities. An independent financial adviser will be able to tell you whether any of these products are suitable for you or not. Alternatives to Buying an Annuity There are other ways of using your pension pot to provide you with an income when you retire instead of buying an annuity. For example: Income drawdown. Alternatively secured pension. These are usually only suitable for people who have a large pension pot worth 100,000 or more. Again, an independent financial adviser will be able to tell you if these are suitable for you or not. Choosing a Financial Adviser Financial advice is not cheap but when it comes to making important decisions, like what type of annuity to buy and where to buy it from it is strongly recommended. You need to be aware of the important difference between independent financial advisers and tied advisers. Tied advisers, as their name suggests, are tied to certain companies and will only look at the products being offered by a small number of companies (quite often only one) and so you might not get the best deal that's out there. You are better off seeing only independent financial advisers because they are able to search the whole of the market to help you try and get the best deal.

14 12 Paying for Financial Advice: Fees or Commission? There are two ways of paying for financial advice paying a fee or paying commission. Fees can vary a lot from adviser to adviser but even expensive fees can work out cheaper than paying commission. Commission is paid for out of product charges which will have an effect on the amount of income that you receive in exchange for your pension pot. Over time, commission charges might end up costing you more than if you had just paid a fee up front. Shop around for independent financial advice and ask for quotes for fee-based advice and commission-based advice. Advisers are often willing to negotiate on the amount of the fee they will charge. You can look in your local telephone directory for contact details for independent financial advisers or ask friends or family if they have used anybody who they would recommend. Alternatively, go online and visit any of the following websites to find details of independent financial advisers in your local area: Key Points About Annuities On retirement you can take up to one quarter of your pension pot as a lump sum perhaps all of it if it's a very small pot. You must arrange to use the rest of your pot to provide you with an income. Better annuities which pay a larger income may be available to you if you are a smoker or have health problems. You can tailor your annuity to suit your circumstances. How much income you get will depend on the size of your pot and whether you choose to have extras like protection from inflation or cover for your spouse/partner. You can buy your annuity from the company you saved with or you can shop around for a better deal called the Open Market Option. Remember once you've bought your annuity there's no going back so it's important to get it right. Please be aware this is a rough guide only. Usdaw cannot provide you with financial advice. We strongly recommend that you seek professional independent financial advice when it comes to buying an annuity. From 1 January 2013 new regulations come into effect that will prevent financial service companies from paying advisers a commission for introducing customers to them. Any business transacted after this date will require the adviser and the customer to agree a fixed fee up front. This will make the cost of getting professional advice more transparent.

15 Pensions Guide to Buying a Pension Annuity Section 3 Further Information 13 Your Annuity Checklist 1. How much is your pension pot worth? 2. How much tax-free lump sum do you want to take? Remember the limit is one quarter of your pension pot. 3. How much is your pension pot worth after you have taken off the tax-free lump sum? 4. Do you want a level or increasing annuity? Level Increasing How much do you want it to increase by every year? Fixed 3% a year In line with inflation 5. Do you want a Single Life or Joint Life annuity? Single Life Joint Life How much of your income do you want your spouse/partner to receive if you die before them? Half (50%) Two-thirds (66%) All (100%) 6. Do you want your annuity to be guaranteed? No Yes How long do you want to guarantee your annuity for? 5 years 10 years 7. Are you a smoker or do have a health condition that might make you eligible for an enhanced annuity? No Yes* *Make sure you tell your adviser or annuity provider to see if you can get an enhanced rate. 8. Have you visited the website of the Money Advice Service to check to see if there is another company that can offer you a better annuity rate than your own pension provider? Yes No 9. Have you considered getting professional independent financial advice to help you do a thorough search of the annuity market to make sure you get the best deal? Yes No

16 Improving workers lives Winning for members Helpline Scan the code with your smartphone to view the latest news and resources about Usdaw s Pensions Awareness Campaign on your mobile* *to scan the code, download a QR reader app from your app store. A charge may be applied by your network provider. Published by: Usdaw, 188 Wilmslow Road, Manchester M14 6LJ. April 2012 Lft No. 377