Taking an annuity – understand the risks - Pensions - Guides - Moneyfacts


Taking an annuity – understand the risks

Taking an annuity – understand the risks

Category: Pensions

Updated: 05/04/2016
First Published: 13/03/2015

An annuity had, up until April 2015, been the main method used of taking a retirement income from a pension. In most cases, it was the only thing people could do. Now, the pension freedoms mean retirees have a whole host of new ways to obtain an income – essentially, they're there to stop annuities being the sole option.

It's important to remember that an annuity is still the only method of ensuring that you'll receive an income for the rest of your life, however long that may be. You will never be without an income in retirement with an annuity.

But, there are still some risks, and it's important to be aware of them. We've outlined them below.

Risk 1 – Value for money

Annuities have received very bad press for being poor value. Under this arrangement, when you retire, you essentially exchange your pension pot for an income. The annuity provider will quote an annuity rate which will determine the income you get for the rest of your life. But, annuity rates have been reducing steadily over the last few years, and so annuity income has fallen as a result.

The Government has suggested that it may be possible to sell unwanted annuities in the near future, but it is still unclear how the value of these will be worked out, so it will be important to ensure you get value for money if you sold an annuity for a cash lump sum.

Risk 2 – What happens on death?

The pension freedoms offer new opportunities when this happens. Under the previous system, your annuity provider used to keep whatever was left of your pension pot after you died (unless you lived longer than expected and actually got more income than your original pension pot was worth). This meant that if you died soon after taking an annuity you could be a big loser.

However, some annuities will now permit the return of unused funds to beneficiaries (possibly subject to tax). To get this benefit, you have to select 'Value Protection' when you take out your annuity, otherwise it's too late. This may also reduce your annuity rate, and therefore the amount of income you get from your annuity.

Risk 3 – Your state of health

Your state of health can be key when determining the level of income you get from an annuity. It's important to tell your provider about any health issues you have, because if you have a condition that could shorten your life (such as heart issues), you could qualify for an enhanced annuity rate - which means your income will be higher. This is because the annuity company will expect to pay the annuity for less time.

Some pension providers don't offer enhanced annuity rates based on health, so it is vital to shop around to find the best rates based on your personal situation.

Risk 4 – Your choice of annuity

Annuities can be set up in various ways, depending on your choices. For example:

  • You can have a level annuity, which means the income won't rise in the future. You get more income now, but it won't rise to keep up with inflation.
  • Maybe you have a partner who has no pension savings themselves, leaving them without an income if you were to die. In this case, you could set up an annuity so the amount is guaranteed to be paid for a certain time (e.g. five or 10 years from when the annuity first starts), or one that paid a proportion of your annuity to your partner for their lifetime after you die. Both options will reduce the income available at the start of the annuity.

What next?

The pension flexibilities give retirees many more options, but they've also complicated things, and it's vital to think carefully before making any choices that you can't undo in the future.

The Government's Pension Wise Service should be the first port of call for most people, and you may want to seek independent financial advice, too. Alternatively, if you'd like to consider your annuity options in more detail, consult our no-obligation annuity planner to see what's available.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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