What Is An Annuity?
Voltaire once famously said…
“I advise you to go on living solely to enrage those who are paying your annuities. It is the only pleasure I have left.”
Hopefully, once you retire annoying Insurance Companies won’t be the only pleasure you have left, but having a reliable income in retirement will allow you to continue to enjoy the things you enjoy most. Purchasing an annuity is one way to provide such an income.
First let’s look at what they are…
So what is an annuity anyway?
An annuity is a contract between an insurance company and an individual which, once purchased, (at retirement) agrees to pay a guaranteed set income for the rest of the individuals life. They are normally purchased with savings accrued through an individual’s pension.
However, in recent years there have been big changes in pensions which means annuities are not the only option open for you now.
Let’s have a closer look…
FROM 6 APRIL 2015 THE WAY YOU COULD TAKE YOUR RETIREMENT SAVINGS CHANGED.
These changes can have implications if you get it wrong.
For example, you may create a large tax bill that you wouldn’t otherwise have had.
Also, not all your pension plans may allow this new freedom of choice.
You may have to move the money to an environment that does allow it.
This might be a good thing to do; it might just as easily be a bad thing.
You can avoid getting it wrong with the right advice.
Taking a Tax-Free Lump Sum
You can take 25% of your pension fund as a lump sum, completely tax free. This hasn’t changed and has been this way for many years. The one major change though is that you do not have to take all your tax-free cash in one go now. Many schemes previously used a ‘use it or lose it’ policy.
Creating A Retirement Income
There are two ways you can use your pension to do this: buy an annuity or invest in flexi-access drawdown.
The Annuity Path
An annuity will pay you an income until you die.
This is the annuity’s big advantage and makes it the starting point for all your retirement planning.
We believe it’s essential for you to receive a regular income to cover your day-to-day expenses.
However, guarantees come at a cost.
The amount of income an annuity pays you depends on two things: the size of your pension fund, and how long you might live based on how old you are now. So, the older you are the more income you will receive. Your annuity payments form part of your total taxable income and incur income tax.
You can also choose what type of annuity you have:
One that pays you a guaranteed income until you die and then stops or one that pays you a guaranteed income until you die and then continues to your surviving spouse or dependent.
One that stops paying as soon as you die or one that guarantees to pay out for a minimum time, for example five years, even if you die earlier one where the income stays the same or one where the income increases each year.
Each option you add makes the annuity more expensive and reduces the income it pays you. A suitably qualified adviser will be able to help you make the right choice for your circumstances.
Shopping Around – The Open Market Option
You do not have to accept the annuity your pension provider offers you.
If you do one thing and one thing only, make sure you shop around for the best annuity you can get.
This may sound like obvious advice but around 60% of retired people do not. (Source: Financial Conduct Authority – 2014 thematic review.) Shopping around for the best annuity can make an enormous difference to your retirement income.
Flexible Access Drawdown
Income drawdown has been around for a while but there were restrictions wrapped around it.
The new retirement freedom removes these restrictions and creates the new flexi-access drawdown.
You can think of flexi-access drawdown as a bit like a bank account.
You keep control of your pension fund, investing it and drawing down income as you need it, when you need it. You have complete flexibility over how much you take out and how often you take it. Once you have drawn your 25% tax-free cash entitlement any further withdrawals form part of your total taxable income and incur income tax
There we are then a simple overview on what an annuity is and the new flexi-access drawdown option.
If you have questions concerning anything I have discussed above, please do give me a call. It’s free from a landline on 0800 321 3508 or call my mobile on 07803 508 187.