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Types of annuity available
Single-life annuitiesThis type of annuity pays income throughout your lifetime and ceases on your death. This is suitable if you do not have a partner or your partner has adequate income or pension to maintain the standard of living even after your death and your income has ceased. Because of the shorter time this type of annuity is likely to pay out, the starting income is higher than a joint-life annuity. If your partner will need some or all of your income after you die then you should consider a joint-life annuity. Joint-life annuitiesIf your partner is dependent on your income or part of it, on your death your partner could find it difficult if your income ends. A joint-life annuity continues to be paid, on your death, to your partner at the full rate or it may be reduced by a third or a half. The level of income at the outset is lower than a single-life annuity but the joint-life annuity could continue to be paid for many years after your death. You need, however, to understand that if your partner dies first then no spouse’s pension is payable and the income ceases on your death. If your partner is a significant number of years your younger the potential longer payment period could mean quite a low starting income. Level annuitiesThe income level is fixed at the outset. This means the same amount is paid year after year. Level annuities pay a higher starting income compared to increasing annuities. However, the effect of inflation could mean that the level of income in real terms is much lower later on in retirement. If your pension fund is going to provide your main income in retirement then an increasing annuity should be considered instead. Escalating annuitiesTo protect your income from rising prices you can choose an annuity that increases each year. The income level at the outset would be lower than a level annuity. It would be some years before your income reaches and goes beyond the rate of a level annuity. It does mean, though, that your income is protected, to a large extent, from the effect of inflation and helps to keep realistic value in real terms. There are two main choices:
If you rely heavily on the amount of income you get from your pension fund, you should consider an increasing annuity. Fixed and escalating annuities are also known as Conventional Annuities. Impaired and enhanced annuitiesIt is possible to get a higher annuity rate if you have a health problem that could reduce your life expectancy to below the average for your age. The more life threatening your condition is considered to be, the higher will be the annuity rate paid. Some companies may enhance rates by taking account of certain lifestyle aspects such as smoking, being overweight, where you live or the work that you did. Protected-rights annuitiesYour pension fund or part of it may have accumulated because you were contracted
out of the additional State Pension, formerly known as SERPs but now known
as the State Second Pension. The pension fund is known as Protected Rights
(or Guaranteed Minimum Pension under an occupational pension scheme). Guaranteed periodMany people are concerned that after many years of contributing to a pension their early death, only one or two years into retirement, would mean that a small amount had been paid out and would represent poor value – particularly in the case of a single life annuity. By taking a small reduction in the level of income it is possible to guarantee that the income would be paid for at least an initial period into retirement. The more common options are a 5 or 10 year period. This means, with a 10 year guaranteed period, that should you die within the first 10 years of retirement the income would be payable in full for the remainder of the 10 year period. So if you died after two years the full amount would be payable, probably into your estate, for a further eight years. More commonly it is commuted into a one off lump sum. At 10 years, in this example, the payments on a single-life annuity would cease; on a joint-life annuity the payments would continue as a spouse’s pension at the agreed rate, unless, of course, your partner had died earlier. If you live beyond the guaranteed period the income will continue to be payable for the rest of your life. Capital protected annuitiesWith effect from 6 April 2006 a new type of annuity is now available, a Capital Protected Annuity, this is where if you die before the age of 75 you can arrange for your estate to receive a return of part of the pension fund after a tax charge of 35%. For instance, if you retire with a pension pot of £100,000 and have received income of £50,000, the remaining £50,000 will be returned less 35%, meaning a total of £32,500. Investment linked annuitiesThe level and escalating annuities that we have looked at so far are linked to fixed interest assets such as gilts (loans to the Government) and bonds (loans to companies). By using fixed interest assets the level of income can be guaranteed for life. Investment linked annuities differ in that they are linked to the stock market and in return for the increased risk there is the chance of a higher income. This means your income is not guaranteed. This risk may not be acceptable to some as your income is likely to change each year, based on the performance of the investment, and could go down as well as up. It is impossible to predict the size of any increase. The types of investment linked annuities are:
We would expect a customer to take advice before setting up either type. With Profits annuitiesYour income is linked to the performance of the Insurance Company’s With Profits fund. Initially your income is set at a low level. This amount can include an assumption of no bonus additions or an assumption of bonuses, usually up to 5%. If the bonus rate announced each year matches your level of assumed bonus then your income remains the same. If it is higher your income increases but if it is lower then your income falls. If you set your income with an assumption of no bonuses (the lowest amount) and each year the company declares a bonus then your income will increase each year. In practical terms your income cannot fall. However, you need to be aware that in exceptionally adverse investment periods the minimum starting income could be cut, unless the annuity, as in some cases, carries a guaranteed minimum. If you set your income at a higher level, for example assuming a 3% bonus and the bonus declared each year is 3% then the income stays the same. If it is different the income will rise or fall accordingly. Unit linked annuitiesYour income is linked to an investment fund which is selected to suit your attitude to risk. In the same way as With Profits annuities, if the investment rises or falls then your income will rise or fall. The more riskier the fund chosen the more your income may vary – both up and down. Unit linked annuities are higher risk than conventional or With Profit annuities. You should avoid this type of annuity if:
Important notes – please readDo you need advice? – These web pages contain product specific details only and unless we have complete up to date written details of your financial circumstances and requirements we cannot and will not offer any opinion as to the suitability of any product for any client. Any response to these web pages will therefore be on the basis that client specific advice has not been given. These investments are not suitable for everyone. If you have any doubt whether they are suitable, you should obtain expert advice. Taxation – Please remember that the annuity income will be treated as earned income and will be taxed at your highest rate of tax, as it will sit on top of your other income, including the State Pension. The Pension Commencement Lump Sum is currently tax free. Levels and bases of, and relief’s from, taxation are subject to change. |
