FSA guide to annuities and income withdrawal

Transcription

1 The Financial Services Authority (FSA) is the independent watchdog set up by government to regulate financial services and protect your rights. January 2004 FSA guide to annuities and income withdrawal Financial Services Authority To help us maintain and improve our service, we may record or monitor calls. If you have difficulty with this material in its current format or language, please call the Consumer Helpline. FSA Consumer website: Comparative tables website: FSA Consumer Helpline: (calls charged at local rates) The Financial Services Authority, January FSA ref: CRED19dP. ttp ref: 4630 FSA regulating financial services and protecting your rights

2 The Financial Services Authority (FSA) is the independent watchdog set up by government to regulate financial services and protect your rights. By law, most financial services firms must be authorised by the FSA. We aim to ensure that all firms we regulate are run in a prudent and financially sound way, and regulate the way many of them do business with you. Firms established in another European Economic Area (EEA) state are authorised by that state although the FSA may regulate some aspects of the way they do business with you. Always check that the firm you are dealing with is authorised. Solicitors, accountants and actuaries do not need FSA authorisation to carry on a limited range of financial services so some of them will not be FSA authorised. Contents Asking the right questions. Introduction 3 Why do I need an annuity? 5 Choosing the right annuity 8 The main types of annuity: 10 How annuity rates vary according to age, sex and type 13 Level annuities 14 Increasing annuities 15 Annuities if you have a partner 17 Investment-linked annuities 20 Retiring gradually 26 Income withdrawal 28 Where to buy annuities 31 Where to get advice 34 Complaints 36 Useful contacts 37 The FSA here to help you make more sense of your money 1

3 This booklet is an introductory guide that outlines the main ways of converting your pension fund into an income for your retirement. It is general information designed to help you ask the right questions and so make informed decisions and the right choices. For financial advice specific to your individual circumstances, you should consult an authorised financial adviser. For help in finding one, see the FSA guide to financial advice or visit the FSA website at Information in this booklet is based on the legal and tax position at December The government announced in December 2002 proposals to reform the pension taxation rules. One of its proposals is that the earliest age from which a personal pension may be taken should increase from 50 to 55 by You can see these proposals on the Department for Work and Pensions website at or call the DWP Orderline for a copy. Introduction A guide to making decisions about buying an annuity if you are retiring soon. What is an annuity? An annuity is a special investment sold by insurance companies. It is a way of converting a lump sum, usually the pension fund you built up during your working years, into an income during your retirement. This booklet is for you if you will get your retirement income from: a personal pension; a stakeholder pension scheme; a group personal pension plan arranged through your employer; a retirement annuity contract (similar to a personal pension but sold before July 1988 when personal pensions first became available); the type of additional voluntary contribution (AVC) scheme that builds up your own investment fund; a free-standing additional voluntary contribution (FSAVC) scheme. This booklet may also be relevant if you will be getting retirement income from: the type of employer s pension scheme that builds up your own retirement fund called a defined contribution or money purchase scheme; a Section 32 policy if you have used this to transfer out of your employer s pension scheme. 2 3

4 Why do I need Head an annuity? This booklet does not apply to any final salary (defined benefit) pensions under an employer s pension scheme. In these schemes, your income in retirement is provided by your pension scheme and you do not need to buy an annuity yourself. But you may, if you wish, buy a purchased life annuity with your tax-free cash sum see page 6. Start thinking about your annuity choices at least four months before you retire. You will have some important decisions to take as you approach retirement that should include your partner. For example: how to provide an income for your partner after you die; whether to protect your income against inflation; whether you are willing to expose your income to investment risk. This booklet outlines the main choices available to you and highlights some of the things you will need to think about. You should also read the FSA factsheet Your pension it s time to choose available from our Consumer website or Helpline see Useful contacts page 37. By law, with some exceptions, eventually you must buy an annuity with your pension fund. An annuity is a special type of investment because, apart from a temporary annuity, it will pay you an income for the rest of your life. Unlike other investments, it cannot be used up, however long you live, neither can it be stopped or sold. Pension plans and schemes are generally a good way to save for retirement because the government gives you tax relief while your savings build up. But the government also restricts how you can use those savings called your pension fund when you decide to retire. Often, you can take up to a quarter of the pension fund in cash, as a tax-free lump sum. The exact amount depends on Inland Revenue rules ask your pension fund administrator how much you are entitled to. The remaining fund must be used to provide taxable retirement income. Many people invest their tax-free cash elsewhere, either to provide more income or for capital growth. If your fund is from a pension top-up scheme, such as an AVC or FSAVC, you must usually use the whole fund to buy an annuity. Tax-free cash is only available if you started paying into this kind of scheme before 6 April Very small pension funds can sometimes be taken as cash (ie you don t need to buy an annuity). 4 5

5 Purchased life annuities Even if you need income, it is often worth taking the maximum tax-free cash sum, though this is not always the case so take advice. You can use it to buy a purchased life annuity. This is similar to the pension annuities described in this booklet but a purchased life annuity is taxed more favourably. You can also buy a purchased life annuity with any other fund of money (annuities bought from your pension fund are called compulsory purchase annuities ). Remember though that once you buy an annuity you can t normally convert it back to cash. There are two ways of converting your pension fund into retirement income. You can: buy an annuity; or choose income withdrawal before buying an annuity. Buying an annuity After taking any tax-free lump sum, you use the whole of your remaining pension fund to buy an annuity from an insurance company. The annuity then pays an income for the rest of your life. Once you ve bought an annuity, you can t get back any of your pension fund as a lump sum, but the annuity will carry on paying out however long you live. It will stop paying out on your death, unless you take out a joint-life annuity or one with a guarantee period. See pages 17 to 19. There are different types of annuity see pages 10 to 25 for help choosing between them. And, like most things, it often pays to shop around for the best rates see pages 31 to 33. Open market option You are free to buy an annuity from any insurance company. You don t have to buy it from the company with which you built up your pension fund if you can get a better annuity rate elsewhere. You can check annuity rates on the FSA s comparative tables website at Government rules currently say that (after taking any tax-free lump sum) you must use all your pension fund to buy an annuity by age 75 at the latest. If you have more than one pension plan or scheme, you don t have to buy an annuity at the same time from all of them, though you might be able to get better rates by combining them see page 33. Income withdrawal Instead of buying an annuity straight away, you can leave your pension fund invested and draw an income direct from the fund. Normally, you should only consider doing this if your pension fund is more than 100,000, after you have taken any tax-free cash. Page 28 explains more about income withdrawal. At any time, you can stop income withdrawal and buy an annuity instead. In any case, you must use all the remaining fund to buy an annuity by age 75 at the latest. When your pension starts Under current government rules, you can normally start to take a pension at any age between 50 and 75 though your own scheme may fix a particular age somewhere between these limits. 6 7

6 Choosing the right annuity The choices you make now will affect you and your partner throughout retirement. The many different types of annuity are described on pages 10 to 25. What kind of annuity you choose depends on your particular circumstances and needs. But a very important factor in your choice is your attitude to risk. Obviously, you want to retire on the highest pension you can get. But don t just look at your circumstances on the day you retire think about your own future needs and those of your family. The type of annuity you choose at the outset, and the benefits it provides, will affect the amount of income you get, both initially and over the years. Because you can t normally change your annuity once you ve bought it, it is vital to check all the options so you buy the one that best suits your needs. Normally, taking care of the long-term future means accepting a lower starting income from your pension, but this will usually be worthwhile if: anyone is financially dependent on you. If you have a wife, husband, other partner or child who is financially dependent on you, you should normally buy the type of annuity that will give them a pension when you die see page 17. your pension is a main source of income. Consider annuities that might protect your income against the effects of future inflation see page 15. If you don t, you may start off with a higher income in the early years of your retirement, but you will be able to afford less and less as time goes on. you want to prepare for future health needs. In later retirement, you might need more income than you did at the outset, to help you cope with disability or health problems. This is another reason to consider an annuity that increases over the years see page 15. With some annuities there is a chance of your income going down, as well as up, so you need to think about whether you can afford this risk see page 20. Because there are many different sorts of annuities, you need time to choose the one that best suits your needs, and to shop around for the best deal see page 31. Start thinking about your annuity choices at least four months before you retire. 8 Check annuity rates online at 9

7 The main types of annuity There are different annuities to suit different needs. The next few pages describe the main types of annuity: level; increasing; annuities if you have a partner; and investment-linked; and how they can meet your need for income during your retirement. New types of annuity products are being developed all the time, so make sure you are aware of all the available options and take specialist advice if you re not sure. How annuities work The amount of income an annuity provides each year in return for the lump sum from your pension fund is called the annuity rate. The amount of income an annuity will pay depends on: the amount you have in your pension fund; the amount of tax-free lump sum you take (not usually available with AVCs or FSAVCs); the annuity rate offered by the insurance company; your age, your sex and your health at the outset; the benefit options you choose, such as whether it is just for you or for a partner as well. The income you get from your annuity is taxable. Annuity rates are usually quoted for a man or woman of a given age. Usually, the starting income from the same size of pension fund is higher for a man than for a woman. This is because, on average, the life expectancy of a man is less than that of a woman of the same age. All annuities have one feature in common: the income you get at the start is higher the older you are. This is because, on average, an older person has fewer years left to live than a younger person. So an older person s pension fund does not have to last so long. The summary chart on page 13 shows you how rates vary according to your age, sex and the type of annuity you choose. If you die soon after buying an annuity, it will not have paid out much. To guard against this, you can choose an annuity with a guarantee period see page 18. You can usually choose to have your income paid every month, every three months, every six months or once a year. You can also usually choose to be paid in advance or in arrears. You normally receive less if you choose payment in advance. Take time to explore your options and seek specialist financial advice if you need it see page 34. Impaired and enhanced annuities Some companies offer annuities that pay you a higher-than-normal income if you have a health problem that threatens to reduce your lifespan these are called impaired-life annuities. Relevant health problems might include, for example, cancer, chronic asthma, diabetes, heart attack, high blood pressure, kidney failure, multiple sclerosis or stroke. You might be able to get an enhanced annuity if you are overweight or smoke regularly. Some companies offer better rates to people who have followed certain occupations, and to individuals living in certain parts of the country shop around! 10 11

8 You may see an annuity rate expressed as a percentage, or as so many pounds of income for each 10,000 you have invested in your pension fund. For example, an annuity rate of 6% is the same as 600 a year income for every 10,000 in your pension fund. The examples used opposite (and elsewhere in this booklet) are based on annuity rates in December 2003, on the FSA Comparative tables website and are for illustration only. Annuity rates when you retire will probably be different. Annuity rates are changing all the time. In general, the annuity rate at the time you buy your annuity sets your income throughout retirement. Later changes in annuity rates do not affect your annuity income. Check them yourself as you near retirement and shop around for the best deal see page 31. How annuity rates vary according to age, sex and type. This chart gives an indication of the pre-tax monthly pension income from your annuity that could be purchased in 2003 for a lump sum of 10,000. The figures in the joint life columns assume that the person buying the annuity is male and is five years older than his female partner. These figures are only an illustration at one point in time, to help give you an idea of what you might get. Annuity rates change frequently for a number of reasons. Types of annuities Joint lives Joint lives Single life (no reduction on death (reducing by 1 /3 on death of scheme member) of scheme member) Male 60 Male 65 Female 60 Female 65 Male 65 Female 60 Male 65 Female 60 /mth /mth /mth /mth /mth /mth Notes to the chart opposite 1. Level (no guarantee period): The income provided is the same each year for the rest of your life. 2. Level (guaranteed 5 years): The income is the same each year but is guaranteed to be paid for at least 5 years, regardless of when death occurs. 3. Increasing 3% each year (no guarantee period): The income increases each year by 3% but stops immediately on death. 4. RPI linked. The income increases each year by the retail price index (RPI). 5. Joint lives: On the death of the scheme member, the income continues (at the level you select when you take out an annuity) to the member s spouse/partner for the rest of his/her life. 6. Better rates may be available for people with health problems, or who have followed certain occupations see page Source: FSA Comparative tables website. December The annuity rates in the chart are for illustration on 10,000 only. The income from an annuity will vary depending on the sum invested. Level annuities Level (no guarantee period) Level (guaranteed 5 years) Increasing annuities Increasing 3% each year (no guarantee period) RPI linked (no guarantee period)

9 Level annuities. Increasing annuities. A fixed income but vulnerable to inflation. A level annuity (sometimes called a standard annuity) pays the same income year after year for the rest of your life. The main drawback of a level annuity is that what you can buy with the income falls as prices rise. For example, suppose at the start of retirement your groceries cost 50 a week. If inflation averages 3% a year for ten years, their cost would rise to 67 a week after ten years. If you could still afford only 50, you would be able to buy fewer groceries. That s the effect of inflation. Is this type of annuity for you? Level annuities pay a higher starting income, compared to increasing annuities, which only start to provide better value some years into your retirement. But think carefully about this effect. Could you cope with having no increases at all in your annuity income during your retirement? If not, check the alternatives using the chart on pages 24 and 25. Example of level annuity Harry retires at age 60 and has a good chance of living another 25 years or more. After taking a taxfree lump sum (see page 5), his remaining pension fund is 40,000. He chooses a single-life level annuity with no guarantee period. This pays him around 2,520 a year ( 210 a month or 48 a week). Even if inflation averages just 3% a year, the buying power of Harry s pension would fall dramatically as retirement progresses. After ten years, his 2,520 annual pension would buy only the same as 1,875 today. After 20 years, its buying power would have fallen to around 1,395 a year. And, after 30 years, its value would be just 1,038 a year well below half its starting value. If inflation is more than 3% a year, the buying power of Harry s pension will fall even further and faster. An income with some protection against inflation. To protect your income from rising prices, you can choose an annuity that is designed to increase each year. There are two main choices: fixed-rate increasing annuities your income is guaranteed to increase at a fixed rate each year, commonly by 3%; RPI-linked annuities your income is adjusted each year to reflect changes in the Retail Prices Index (RPI) the main measure of inflation used by the government. So, if inflation is 2% one year, your income goes up by 2%. If inflation is 3% next year, your income goes up by 3%. However, your income is not guaranteed to increase each year if the RPI did not rise, neither would your income. If the RPI fell, so would your income. The proceeds of some pension plans and schemes must be used to buy a limited price indexation (LPI) annuity. With these, your income normally rises each year in line with the RPI but only up to a maximum of 5% a year. Unlike an RPI-linked annuity, your income under an LPI annuity could not fall, even if the RPI did. Ask your pension provider if you have one of these schemes or plans. With an increasing annuity, the starting income is a lot lower than you would get from a level annuity. For example, for a man aged 60, the starting income from a 3% increasing annuity might be twothirds or less of the amount from a level annuity. It could take more than ten years for the increasing income to catch up, and nearly 20 years before the total you d received from the increasing annuity exceeded the total paid by the level annuity. Is this type of annuity for you? You are giving up some income today to make sure your income holds its value in the future. You have to live a certain time before the income from an increasing annuity catches up with the amount you could have had at the outset from a level annuity

10 You need to weigh up whether you think you will live long enough to benefit from the protection against inflation offered by an increasing annuity. If you re not sure if an increasing annuity is for you, check the alternatives using the chart on pages 24 and 25. Example of RPIlinked annuity Hannah retires at age 60. After taking a tax-free lump sum (see page 5), her remaining pension fund is 35,000. She chooses a single-life RPI-linked annuity with no guarantee period. The pension starts at 1,428 a year ( 119 a month, or 27 a week). After 10 years, inflation has averaged 2% a year. Her annual pension has increased to 1,741 a year. This means she can still afford to buy the same as she did with 1,428 ten years ago. Over the next ten years, inflation averages 5% a year. Hannah s annual pension increases to 2,836 and keeps its original buying power. Annuities if you have a partner Make sure your partner will still have an income if you die. Joint-life annuities Both conventional and investmentlinked annuities can be single-life or joint-life. See page 20 for an explanation of investment-linked annuities. A single-life annuity pays out only during your own lifetime. Your partner will get nothing when you die. A joint-life annuity continues to pay an income to your partner after your death. On your death, some annuities carry on paying the same amount. With others, the amount is reduced for example, by a third or a half. You usually choose at the outset how much income you want your partner to get. If you are not married check with your provider that your partner is eligible to receive it. With some pension schemes, the law says you must opt for an annuity that provides a pension for your widow or widower equal to half the income you were getting. Your provider can tell you if this applies to your plan or scheme. If you have a wife, husband or partner who is financially dependent on you, you should normally choose a joint-life annuity unless you have other assets or income for your dependants to live on after your death. 16 Check annuity rates online at 17

11 Example of joint-life annuity Jack is 65 and his wife Emma is 60. In December 2003, Jack retires. After taking a tax-free lump sum (see page 5), he has 62,000 in his pension fund with which to buy an annuity. He opts for a joint-life RPI-linked annuity with no guarantee (see pages 15 and 17) which provides: a starting pension for Jack of 2,532 a year; a pension for Emma if Jack dies before her. This will be one-third less than the amount paid when Jack was alive. Based on the starting income, this would be 1,688 a year (2/ 3 x 2,532); increases in line with inflation to ensure that both the original pension and Emma s widow s pension keep the same buying power throughout retirement. Annuities with a guarantee period If you die soon after buying an annuity, it will not have paid out much. To guard against this, you can choose an annuity with a guarantee period. These sorts of annuity commonly guarantee to pay out at least five or ten years worth of income, even if you die within this period. On your death, the income may continue to be paid for the rest of the guarantee period, or it may be paid to your estate (and inheritance tax might be due on it). Ask for quotes for five and ten year guarantees. If anyone is financially dependent on you, do not look on a guarantee period as a substitute for a joint-life annuity. If you live to the end of the guarantee period, the survivor will get nothing after you die. If you choose a joint-life annuity, a guarantee period may be less useful. Example of an annuity with a guarantee period Harriet, 60, retires. After taking a tax-free lump sum (see page 5), she uses the remaining 30,000 pension fund to buy an annuity. She hopes to live to a ripe old age but, if not and having no closer relatives, she would like to leave something to her nephew. She chooses a single-life level annuity with a ten-year guarantee. Harriet gets an income of 1,788 a year. Whatever happens the annuity guarantees to pay out 10 x 1,788 = 17,880. After only two years, Harriet dies. The annuity has paid her a total income of 3,576. The rest of the guaranteed annuity payments continue to be paid to her estate and will be distributed according to her will. All extra annuity benefits cost money by reducing the amount of your initial annuity income

12 Investment-linked annuities. The chance of a higher income in future but only by taking extra risk. Investment-linked annuities offer the chance of a higher income than you can get from level or increasing annuities (often called conventional annuities ) that are linked to fixed-interest assets such as gilts loans to the government and bonds loans to companies. But you need to be comfortable with linking your income in retirement to the ups and downs of the stockmarket. Investment-linked annuities are more risky than conventional annuities because: your income is likely to change each year, and could go down as well as up; the size of any increase is unpredictable. If the risk of an unpredictable, and possibly falling retirement income worries you, stick to conventional annuities. You might wish to take specialist financial advice see page 34. Investment-linked annuities can either be: with-profits (see below); or unit-linked (see page 22). With-profits annuities How with-profits annuities work These link your income directly to the performance of the insurance company s with-profits fund. Typically, your income is made up of two parts: a minimum starting income This is set at a low level but, unless investment conditions are very bad, you ll usually get at least this much income. Some with-profits annuities guarantee it; bonuses The insurance company usually announces bonus rates once a year. Bonuses can be both reversionary (guaranteed to pay out for the duration of your annuity) and special these only pay out for a year or so until the next bonus announcement. The amount of any bonuses depends on many factors, such as: how well investments are doing for example stock market performance; and business risk the financial strength of the fund. For more information on with-profits, see the list of FSA publications on page 39. With a few annuities, a minimum bonus rate for example, 3% a year is guaranteed. Sometimes you can choose the guaranteed rate, but the higher the guarantee, the lower your starting income. Usually, your starting income is based on an assumed (or anticipated) bonus rate (ABR). You choose the ABR at the outset from a range set by the insurance company for example 0% (which assumes no bonuses at all) to 5%. Once chosen, most insurance companies do not allow you to change the ABR. The insurance company announces new bonus rates every year. If the rate equals your chosen ABR, your income does not change. If the declared bonus is higher than the ABR, your income increases. But if the bonus is lower than the ABR, your income falls. If you choose a low ABR, your starting income is low. But you increase the likelihood that future bonuses will exceed the ABR and that your income will rise. You also reduce the risk that your income will fall. If you choose a higher ABR, your starting income will be higher. If you choose the lowest ABR of 0% in other words, assuming no bonuses at all your starting income will be just the minimum. As long as the company declares any bonus at all, your income will increase. In general, your income can t fall, because the bonus rate can never be lower than 0%. (However, if long-term stockmarket performance were very poor, even this minimum starting income could be cut, except in the case of with-profits annuities that guarantee the minimum.) Your choice of ABR may depend on your need for income. For example, suppose you intend to carry on working for now. By choosing a low ABR, you can plan for a low income now, increasing by the time you fully retire. Check annuity rates online at

13 Example of withprofits annuity Unit-linked annuities Chris is 60 and about to retire. He uses his 100,000 pension fund to buy a with-profits annuity. The starting income depends on the ABR (see page 21) that Chris chooses. His options are: the lowest ABR of 0% Chris starting income would be 4,600 a year. But, provided the insurance company announces any bonus at all, his income would normally increase each year. the highest ABR of 5% Chris starting income would be much higher at 7,800 a year. But his income would increase in future years only if the actual bonuses were more than 5%. Every time the insurer announced a bonus of less than 5%, his income would fall. an ABR between 0 and 5% This gives a starting income of more than 4,600 but less than 7,800 a year. Ask the insurance company to provide examples to show how your income can go up or down each year, depending on the actual bonuses announced. How unit-linked annuities work Your income in retirement will be linked directly to the value of an underlying fund of investments. Generally, you can choose the types of fund, for example: medium-risk managed fund where a fund manager selects a broad range of different shares and other investments spreading your money widely reduces risk; higher-risk fund where a fund manager selects shares and other investments in a particular country Japan, say or sector, such as smaller companies. Because your money is less widely spread, the risk is higher; tracker fund (usually medium risk) which tracks the performance of a particular stockmarket index. Usually, these have lower charges than managed funds. The more risky the underlying fund you choose, the more your retirement income may vary both up and down. Some unit-linked annuities work in a similar way to with-profits annuities. Your starting income is based on an assumed growth rate (this works like the assumed bonus rate explained on page 21). If the fund grows at that assumed rate, your income stays the same. If growth exceeds the assumed rate, your income increases. If growth is less than the assumed rate, your income falls. A few unit-linked annuities let you invest in a protected fund which limits the fall in your income. Most unit-linked annuities do not guarantee any minimum income. Even if your income is based on an assumed growth rate (see above) of 0%, your income could still fall if the value of the underlying investment fund falls. You should not consider a unit-linked annuity unless you can cope with an income that may swing widely and may fall. You would need a large pension fund or other sources of income (or both) to fall back on. If you are not comfortable with fluctuations in your retirement income, check the alternatives using the chart on pages 24 and 25. Unit-linked annuities are higher risk than either conventional or with-profits annuities. Check annuity rates online at

14 Use this chart to help you choose a suitable annuity. Start Do you have a wife, husband, or other partner? Yes Whatever other annuity options you choose, you should normally consider a joint-life annuity see page 17. Now follow the arrow to check the other options. No Will this annuity be a major source of your retirement income? Yes No You could consider a level annuity (see page 14) but be aware that, because of inflation, it will buy less and less as time goes on. To guard against this, follow the arrow to check out alternative annuities. Do you have a pension fund of more than 100,000 to buy this annuity? Yes No Consider: a fixed-rate increasing annuity (which increases by a fixed amount each year) see page 15; or an RPI-linked annuity (which normally increases in line with inflation) see page 15. Would you be comfortable with an income that could fall as well as rise? Yes No Consider: a with-profits annuity with a 0% ABR see page 20; or phased retirement see page 26. Consider: a with-profits annuity (see page 20); or a with-profits annuity with a higher ABR (see page 20); or a unit-linked annuity (see page 22); or income withdrawal (see page 28). If you would like your annuity to be guaranteed for a specific number of years so that it will continue to pay the income (usually to your partner or estate) if you die before the time period is up, choose a guaranteed annuity see page Check annuity rates online at 25

15 Retiring gradually Phased retirement uses annuities to provide a flexible income. Most personal pensions can be arranged as a single plan, or as a cluster of many separate plans, sometimes called segments. The segments can then be used to buy annuities at different times. All the segments must be used to buy annuities by the time you reach the age of 75. This process is called phased retirement. Phased retirement is complicated and requires thought, planning and management. You ll probably need some specialist financial advice see page 34. Each time you convert a segment to an annuity, you can first take part of the segment s fund as tax-free cash (see page 5). Converting segments regularly for example, once a year means you can effectively use the tax-free cash, as well as the annuity, to provide your income. The drawback is that if you stagger the conversion of segments into annuities, you will not be able to take all your tax-free cash from your total pension fund at once as a single lump sum. You must convert enough segments each time to buy an annuity. Insurance companies often set a minimum purchase price. Phased retirement can be a very useful financial planning tool, for example, if you want to ease back gradually on work and start to replace your earnings with pension income. It also provides more flexible help for your survivors if you die. Segments that have not yet been converted to annuities can provide a pension for your surviving dependants or a lump sum, depending on the terms of the pension plan. By taking an income in this way you are reducing your pension fund and relying on investment growth to replace part or all of what you have taken. Phased retirement is generally suitable only if you have a fairly large pension fund, or have other assets or income to live on. This is because the bulk of your pension savings remain invested usually in the stockmarket which may be more risky than buying an annuity straight away

16 Income withdrawal An alternative to buying an annuity until age 75 at the latest. You do not have to buy an annuity straight away when you want to start taking an income from your pension fund. Instead, you can put off buying the annuity until as late as age 75, though it is a good idea to review this decision regularly. In the meantime, you can take an income direct from your pension fund this is called income withdrawal or income drawdown. If you want to take part of your pension fund as a tax-free lump sum (see page 5), you do this before starting to take income from the fund. The income you take out of your remaining pension fund is taxable. Income withdrawal is an option with some personal pensions and some money purchase employer s schemes. But sometimes, if you are in an employer s scheme and want to use income withdrawal, you must first transfer your pension rights from the employer s scheme to a personal pension. There will probably be charges for making this transfer. Income withdrawal involves extra costs and extra investment risk compared with buying an annuity straight away. For this reason, it is usually suitable only if you have a pension fund of over 100,000 (after taking any lump sum) or you have other assets and sources of income to fall back on. Because the bulk of your savings remain invested in the stockmarket, the value of your pension fund can go down as well as up. Provided you understand these risks and feel comfortable with them, there are several reasons for considering income withdrawal: you want the flexibility to vary the amount of pension income you take. Maybe you need the cash lump sum but have little immediate need for income. Or perhaps you are retiring gradually and need a flexible and increasing income; you want to leave your heirs the bulk of your pension fund (though a tax charge would be deducted) if you died before reaching age 75; you are confident that your pension fund can be invested for a better return than you would have got from an annuity. This almost certainly means investing in sharebased investments and you must feel comfortable with the stockmarket risk; you want to avoid being locked into current annuity rates and want to wait until they rise. But bear in mind that future annuity rates could fall. The Inland Revenue limits the maximum income that people can take out of their pension fund through income withdrawal. The maximum is broadly the same as a level annuity for a single person of your age and sex. Like annuity rates, this maximum often changes. Current Inland Revenue rules also require you to take at least a minimum income which is set at 35% of the maximum. The company that you invest with must review your income withdrawal arrangement every three years. This is to make sure that your income stays between the Inland Revenue s minimum and maximum limits. This means you may have to take a cut in income if you had been drawing the maximum or an increased income if you had been drawing the minimum. Think about reviewing your income every year as well as the decision on when to make the final annuity purchase. Example of income withdrawal Dan retires at age 55. He will have 250,000 in his pension fund after taking a tax-free lump sum (see page 5). Since annuity rates are relatively low for someone as young as Dan, he is interested in income withdrawal. His financial adviser works out the current limits on the income Dan can take. The maximum is 17,500 a year and the minimum is 6,125. These limits will apply for three years, after which they will be recalculated and will probably change

17 If you opt for a high withdrawal rate and investment returns are poor, income withdrawal may run down your pension fund too quickly. There is a danger of running it down so far that, when you eventually have to buy an annuity, you can afford only a very small income for your remaining retirement. For more detailed information, see the FSA Factsheet Income withdrawal a retirement option for you? Phased retirement (see page 26) and income withdrawal can be combined This means you would start to draw an income from just part of your pension fund on one date, leaving the rest of the fund intact. To increase your income at a later date, you could either increase the rate of withdrawal (provided you did not exceed the maximum limit) or start to draw an income from a further slice of your pension fund. This option is very flexible, but complicated. Get professional advice see page 34. Income withdrawal is complicated and risky, so get advice see page 34. Where to buy annuities Annuities are sold by insurance companies shop around for the best deal. As with most things, shopping around can get you a better deal. Although you can usually buy an annuity from the same company with which you built up your pension fund, do not assume it will automatically offer you the best rate. You may do better by shopping around and checking if another company could offer you more. In most cases, you can use your pension fund to buy an annuity from another company. This is called using your open market option. Your insurance company must tell you about this and explain the advantages and disadvantages. Make sure you ask for all the information you need to shop around for the best deal. Before shopping around, make sure you understand what your provider is offering you. Does the company holding your pension fund offer you a guaranteed annuity rate? (In the past, some insurance companies sold these sorts of plans. Now that annuity rates are a lot lower, these guarantees can be very valuable, but might not apply to the type of annuity you need.) Other points to consider: Will your existing company impose a penalty charge if you buy your annuity from another company? Does your fund need to be a specific size to qualify for the better rates offered by another company? You may find it difficult to shop around if you have a small pension fund (say less than 5,000). Some firms may not be interested in advising on small sums, or might have high charges for this service

18 Do you have a medical condition that could reduce your life expectancy? see page 11. Some providers of impaired life annuities are interested in pension funds smaller than 5,000. Some companies are keen to attract annuity customers, so they offer competitive rates; others are less keen. The company you choose can affect your income by hundreds of pounds a year. When comparing different quotes, make sure they are based on identical benefits as there are many different options to choose from. Annuity rates are available on the FSA s Comparative tables website at Useful contacts, page 37, lists some of the other sources you can use to find out about different companies annuities. Alternatively, get specialist financial advice see page 34. There can be a big difference between the best and the worst annuity rates. You may be worse off in retirement than you need to be if you don t shop around for the best annuity see example opposite. Example of how the open market option can get you a better rate Jerry, aged 65, has a pension fund of 22,000 left after taking a taxfree lump sum. He is single and uses the fund to buy an escalating annuity that will increase by 3% each year. The company with whom he built up his pension offers him an annuity rate of 453 a year for each 10,000 (4.5%). This would give him a pension of 996 in the starting year ( 22,000/ 10,000 x 453). Jerry finds the best rate he can get from another company is 556 for each 10,000. This would provide a starting pension of 1,223 a year ( 22,000/ 10,000 x 556). By shopping around, Jerry has increased his pension by 227 in the first year and even more in subsequent years. More than one pension fund? If you are using more than one pension fund to buy an annuity, think about combining them when you are shopping around larger funds may attract better rates. Advantages of combining your funds: Many of the best-rate annuities have a minimum purchase price. Smaller pensions may be paid less often than monthly. It s often easier to budget with just one payment a month. Possible drawback: The risk of having all your eggs in one basket (especially if you choose an investment-linked annuity and your provider turns out to be a relatively poor performer). Five steps to shopping around for your annuity This is only feasible if done around six weeks before your retirement date. 1. Get an estimate of the value of your pension fund, taking account of any charges, from your pension provider. 2. Decide how much tax-free lump sum you want to take and deduct it from the value given. 3. Decide on whether you want: a single or joint-life annuity; if joint life, whether the pension to your partner is paid in full or reduced (say by one third); a level or increasing annuity; if increasing then by RPI or a fixed rate. 4. Think about whether you might be eligible for an impaired-life or an enhanced annuity. If you think you are, then discuss it with the annuity provider. 5. Think about whether you want an annuity to continue being paid to your partner or estate, for a specific number of years (5 or 10) if you should die shortly after retiring. Now armed with all these facts, you can get quotes from a range of providers. Remember that annuity quotes are fixed for between 7 and 28 days. Once you decide to accept an annuity quote, you will have a 14-day cooling off period in which to cancel, if you change your mind

19 Where to get advice Annuities are complicated, so think about getting some professional advice. Annuities and income withdrawal arrangements are offered by insurance companies. You can get advice about a particular company s products direct from that company or its representatives. Alternatively, contact an independent financial adviser (IFA) who can advise on all aspects of annuities or income withdrawal, including which company will best meet your needs. Financial advisers, whether they are independent or work for a single company, must be authorised to give investment advice. Authorisation protects you. For example, authorised firms have to meet regulatory standards. And, if an authorised firm gives you the wrong advice for your circumstances, you will have access to a proper complaints system and redress. Both company representatives and independent advisers must ask questions about your personal and financial circumstances, so they can give you suitable advice tailored to your circumstances. A few IFAs specialise in giving advice only about annuities or income withdrawal this is sometimes clear from their names, which often include the word Annuity see Useful contacts on page 37 for how to find an adviser. Check that your adviser is authorised by checking on the website or call the FSA Consumer Helpline see Useful contacts on page 37. For more information, see the FSA guide to financial advice. Call the FSA Consumer Helpline for your free copy or order or download a copy from our website see Useful contacts on page 37. How do you pay for financial advice? Insurance company advisers are paid by salary, bonus, or a mix of the two. Other advisers are paid through commission. For annuities, the adviser is usually paid by commission. This is paid by the insurance company, so should not affect the amount you pay for the annuity. But ask if you have to pay the adviser any additional charges. Information you ll get With annuities, you get an illustration showing the amount of pension you would get, given the size of your pension fund, your personal details and current annuity rates. The figures are shown after deducting any sum you have chosen to take as tax-free cash. The illustration also shows how much your adviser will be paid if you take up the annuity. You will also get a Key Features document describing the main aspects of the annuity, such as charges and the risks. Make sure you read and understand the information in the Key Features. In the case of a with-profits or unitlinked annuity, the illustration will include examples of how your annuity income might vary in future years. These projections will be based on standard assumptions about the growth of the underlying investment fund the fund will not necessarily grow at these rates. If you choose a with-profits annuity, you should ask about the company s approach to setting bonus rates. If you are considering income withdrawal, the illustration may include critical yield figures. They show: how much your pension fund needs to grow to let you withdraw an income equal to what you would have got if you d bought an annuity straight away; how much your pension fund needs to grow to maintain indefinitely the level of income you have chosen

20 Complaints Useful contacts There are procedures to help you if things go wrong. Employers scheme pensions If you have a problem concerning a pension from an employer s scheme, first contact the pensions administrator at work. Your employer s scheme must by law offer a formal complaints procedure. If this cannot settle the matter, contact the Pensions Advisory Service (OPAS). It will attempt to mediate between you and the scheme and, if necessary, will help you take your case to the Pensions Ombudsman see Useful contacts on page 37. Personal and stakeholder pensions If your complaint is about the advice you received or the marketing or selling of the pension, then first take up any complaint with your adviser or the personal pension company. Take the case to senior management level if necessary. If the dispute is still unresolved, contact the Financial Ombudsman Service see Useful contacts on page 37. If your complaint is about the way your pension is run, contact the Pensions Advisory Service (OPAS) see above. For more information, call the FSA Consumer Helpline on for your free copy of the FSA guide to making a complaint. This booklet takes you step by step through the process of making a complaint and getting matters put right. For details of pensions from employers schemes The pensions administrator, pensions manager or pension scheme trustees. You usually get in touch via the Human Resources or Personnel Department. To trace pensions you ve lost track of The Pension Schemes Registry (at Opra the Occupational Pensions Regulatory Authority) tel: website To find out about your entitlement to the state pension The Retirement Pension Forecast Team To get an estimate of how much state retirement pension you can expect. tel: website To check the tax aspects of pensions Your local tax office (look in the phone book under Inland Revenue ) website To check current annuity rates FSA Compatative tables website Ceefax Page 260. Moneyfacts Specialist magazines, such as Investment Life & Pensions Moneyfacts try your local public reference library. Moneyfacts faxback service (updated daily) fax: (calls currently charged at a maximum of 75p a minute). Personal finance pages of national newspapers and personal finance magazines, such as Money Management and Planned Savings, available from newsagents and in some reference libraries