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Category: Annuities Date: 12/14/2010
From 6 April 2011 your retirement options will widen. In a recent announcement by the Government, you will no longer be required to convert your pension pot into an annuity by the age of 75.
So the question is: why would you not want to buy an annuity? An annuity is purchased when you retire, if you have a money purchase or defined contribution pension. It provides a guaranteed regular income every month for life and can help you maintain a decent lifestyle in retirement.
But, whilst an annuity can provide you with a guaranteed income for life, it's just that: for life. That means whether you live for another five years or another 50 (which when you consider that you can take an annuity from the age of 55 is possible!) your hard-earned pension pot is kept by the annuity provider, your family don't get a penny when you die.
The new rules mean that you can keep your pension invested and withdraw a certain amount from your pot each year. When you die, your family will benefit from the remaining money, after an eye-watering tax of 55% has been applied. But, of course, that's better than nothing…
The main risks with not buying an annuity and leaving your pension invested are twofold. Firstly, as your pension remains invested (even in low-risk funds) there is a risk that your pot could decrease if the funds you're invested in don't perform well – and at a time of life when you may not be in a position to replace your losses with new money.
The second risk is that you literally empty your pension pot, leaving you with a much reduced income in later years.
Under current rules you can't touch your pension pot until you reach the age of 55, when you can take up to 25% of your pot as a tax-free lump sum. This applies whether or not you decide to buy an annuity.
The reasons for and against buying an annuity can seem quite baffling, so we've created a table to summarise the main differences. Everybody's situation is unique, so this table is not designed to give advice, but to help you come to an informed decision. Choosing how you will take your income in retirement will possibly be the biggest financial decision of your life – be sure to enlist the services of a good financial adviser and to shop around to maximise your income.
Taking an annuity
Not taking an annuity
How much of my pension pot will be passed on to my family when I die?
None. Unless you pass away during a Guarantee period (which is an option you may be able to take and guarantees that your annuity will be paid for a minimum period – typically 5 or 10 years).
After a tax of 55%, your family will receive any money remaining in your pension pot.
How much income will I get, or be able to draw down from my pension?
This will depend on your age, health and a variety of other factors, such as the size of your retirement fund.
The amount of income you can receive from your pension can not be greater than the annuity you could have purchased with your total pension pot. This amount will be reviewed every three years. However, if you have a fund large enough to take an income of £20,000 per year there will be flexibility to withdraw more, albeit with the catch of having to pay income tax on any extra you take.
Is this income guaranteed for life?
Yes.
No. You can only take an income from your pension as long as you have a pension pot! If you end up taking your pension over a long period there is a risk that you will have a reduced income later on, and have to rely on the state or any other assets, savings and investments you have.
Is there any investment risk?
No. Your annuity is guaranteed for life.
Yes. As your pension remains invested there is the chance that your pot could go down due to a poor investment performance.
Can I change later on?
Most annuities will not allow you to change at a later point.
If you wanted to, you could purchase an annuity later.
Are there any other options?
· If you are concerned about leaving your spouse or partner without an income, you should consider a joint annuity that continues until the second person dies. This can be set up to pay the same amount, or a reduced amount after the first death.
· You could opt for a part and part option, purchasing an annuity with some of your pension pot and leaving some invested and withdrawing an annual income. This could provide an inheritance for your family (providing you have not drawn your entire pot as an income).
* This table does not constitute financial advice. It gives an overview of the different options available to you. If you have any doubt, you should seek independent financial advice.
The "Catch 22" is that an annuity becomes better and better value the longer you live, but over a shorter term will not pay you or your estate as much income. The choice you make will depend on what you conceive your pension as being for: is it to provide you with income in your retirement, to provide a financial legacy for your family, or a combination of both. A difficult one for sure, but at least now there are more options…
Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at anytime.