With interest rates now rising, and the cost of living crisis casting uncertainty on many people’s retirement plans, is it now time to take another look at annuities?
What is an Annuity?
An annuity allows you to use your pension pot to buy a secure, guaranteed income. Most annuities will pay this income for life, although there are some shorter-term annuities available in the market.
Some of the benefits you can build into your annuity include:
- A spouse’s pension
- Index-linking, so that your income keeps pace with inflation
- Capital guarantees, so that some of your money is returned if you die in the early years of drawing an income.
The more benefits you add, the lower your income will be at outset to cover the cost.
Your annuity rate is based on various factors, including interest yields, life expectancy, your age, and your health.
Benefits of Annuities
The main benefits of buying an annuity are:
- Your income is guaranteed for life (or the term of the plan).
- You no longer have to worry about investment risk or fluctuations in the value of your pension pot.
- Once they are in place, annuities don’t require ongoing reviews or maintenance. This can save on costs and admin once you retire.
- If you build in index-linking, this offers some protection against inflation.
- There is an option to provide an income for your spouse or partner if you die. This can be up to 100% of the income you receive.
What Are the Downsides?
Of course, annuities are not for everyone. There are a few potential downsides to consider:
- Once you have set up your annuity and the cancellation period is over, you can’t change your mind.
- You can’t add or remove options if your circumstances change. This means you can’t add a spouse’s pension if you get married, nor can you remove it if you are widowed or divorced.
- If annuity rates go up in the future, or if your health changes, it’s not possible to shop around for a better deal once your annuity is in force.
- You can’t vary your income to accommodate your changing needs. Many people find that they spend more in the early years of retirement and less as they get older. Costs can increase again later in life if long-term care is required.
- If you die, your beneficiaries will only receive an income or lump sum if this is included in the contract at outset. If you don’t include a spouse’s pension or capital guarantee, your loved ones won’t receive anything.
Other Retirement Options
If you are unsure about buying an annuity, there are a number of other options available to you:
- Whether or not you decide to buy an annuity, you can withdraw a tax-free lump sum from your pension. This is normally 25% of the value. Many people use their lump sum to supplement their income, which can provide some breathing space while you consider your retirement options.
- Flexi-access drawdown. This allows you to withdraw a flexible income from your pension. You can vary this depending on your needs and can even start and stop. Your pension pot remains invested and can go up and down with the market. You will need regular reviews to make sure the investments remain suitable, and there will be ongoing costs.
- Uncrystallised pension fund lump sum (UPFLS). This means that you withdraw ‘slices’ of your pension pot, which each comprise 25% tax-free cash and 75% taxable income. You can even withdraw the whole pot in this way if you wish.
- Leave your pension untouched. If you have other sources of income or cash in the bank, it can be more effective to use this to meet your everyday expenses rather than your pension. Pensions are extremely tax-efficient, and can even be passed on to your beneficiaries free of tax if you die before age 75.
Factors to Consider
There are several factors to consider when you are thinking about taking a retirement income:
- Do you need to draw an income now? If you don’t need an income from your pension yet, you don’t have to make an immediate decision, even if you have reached your plan’s normal retirement age.
- Would you prefer to prioritise flexibility or security?
- Where does your pension fit into your wider retirement plan? If you have other income and assets, the considerations may be different than if your pension was your only source of financial security. This is particularly true if you feel your income needs will fluctuate in retirement, as you can allocate different assets for specific purposes.
- How do you feel about investment risk? An annuity could be the best option if you want to eliminate all risk. Drawdown could work for you if you are happy to stay invested in the market.
- Consider your health and family circumstances. Would your loved ones be provided for if you were to die? As well as your pension, you should factor in other assets and life insurance policies.
- Remember, if you choose drawdown, UPFLS, or take no action with your pension, you can still buy an annuity later on. Rates generally go up with age, but this is not guaranteed.
The decisions you make at retirement can impact your financial security for the rest of your life. It’s important to think carefully about the options and take advice if required.
Please don’t hesitate to contact a member of the team to find out more about retirement planning.
