How does a lifetime annuity work?
A conventional, lifetime annuity is the simplest method of converting a pension contract into an income.
It is a very simple product, and the basics are relatively easy to understand:- in simple terms, you hand over the proceeds of your pension fund to an insurance company, and they provide you with a secure retirement income for life (annuity).
The income you receive is guaranteed for life, and will be at least payable until the day you die. Under current rules, you can buy an annuity from age 55.
You are essentially exchanging capital, for income. For lots of people, a lifetime annuity can be a good investment.
How much income your annuity provides is based on your age, and the annuity options you select.
Different insurance companies have different views on life expectancy, and the types of business they want to attract. The annuity rates they offer can vary widely from one company to another. So, it always pays to shop around for the best annuity deal for your circumstances, and this is called the “Open Market Option”.
Your current pension company will probably offer you an annuity, but in most instances, this can be bettered by shopping around
How much does a lifetime annuity pay?
Well that depends…
With a lifetime annuity you can build in different features. This is where things can start to get a little confusing.
There are two different options you can have with lifetime annuities:
- Level – this will pay a fixed income that won’t ever change
- Increasing – one that goes up each year, usually by a fixed % or a measure of inflation
What if I were to die?
For most people, ensuring something is left behind to your family or loved one is important. You might think that giving up your pension pot in exchange for an income may mean there is nothing left for your family, however this is false!
You can also build in different “features” onto the annuity to protect your loved ones in retirement.
More often than not, these provide an income to a spouse in the event of your death, either through what is called a “joint life” annuity or a “guarantee period”. We sometimes refer to the features you add on as “bells and whistles”.
If you are building in your spouse, and they are in ill health or older than you, this may not decrease the income paid to you.
You can also build in benefits for children or any beneficiaries of your choosing, or ensure that the income is paid for a minimum period of time. This can be advantageous for some schemes where death benefits are only paid to a legally married spouse, particularly for retirees who are unmarried.
Options to build into an annuity
Level Annuity – An annuity without inflation proofing (a level or fixed annuity) will provide a higher level of initial income but provide no protection against inflation
Inflation Linked Annuity – an inflation proofed, or escalating, annuity will increase each year either by a fixed amount or by the rate of inflation.
Single Life Annuity – this would pay out for only the person who purchaed the annuity and would stop on the death of that person (unless a guarantee period was taken out).
Joint Life Annuity– a joint life annuity means building in a pension to continue for your spouse in the event of your death. This can be anything up to 100% (so what was paid to the person who bought it, will continue after their death).
Guarantee Period – this ensures that the annuity is paid for a minimum number of years, normally 5 or 10 years. How it works; so if you opt for a 10 year guarantee and die after two years, there would be eight more years worth of payments. Very often there is little difference between a five and a ten year guarantee. New rules from April 2015 meant that there will be no maximum, with some providers offering 30 year guarantee periods.
Value Protection – This option permits a return of any unused fund in the event of death. So, it is money paid in (to buy the annuity), minus income paid out – a “money back guarantee”.
Payment Frequency – you can opt for an annuity to be paid monthly, quarterly, half-yearly or annually. Once selected, you can not change it at a later date.
Advance/Arrears – you can opt for the income to be paid as soon as the contract starts by taking the payment in advance, or taking it in arrears, which would mean waiting to receive the first payment. Having the payment payable in arrears will mean a slightly higher income.
The amount you get from the annuity depends on what, and how many, features you build in. An inflation proofed, 100% joint life annuity with a 30 year guarantee period isn’t going to pay as much as a level, single life with no guarantee.
Whatever options you’re considering, it is important to remember to shop around for the best annuity for your circumstances and use your open market option to get the best rate for you. Remember, you don’t have to take out an annuity with the same company you have your pension with.
These are the main options for a conventional annuity. However, there are other types that may be more suitable for you. These include a fixed term annuities or an enhanced life annuity.
Contact us today to get a free lifetime annuity quote.
Are there alternative solutions?
Absolutely! If you don’t think a conventional lifetime annuity is for you, there are of course other options.
The main ones are:
- Enhanced Lifetime annuity – also known as impaired life annuities, these types of annuity are for those who are in ill health. Enhanced/impaired life annuities don’t just apply to serious conditions such as cancer or heart problems. Even relatively minor conditions (especially if there is more than one) can qualify you for an enhanced annuity.
- Fixed term annuity – this is effectively what it sounds like, an annuity that pays out for a fixed period and works in a similar way to a lifetime annuity in that, you hand over your money to an insurance company, they pay an income, and then at the end of the term, depending on the level of income you have chosen, you can get your initial sum back. It could also be lower or higher, depending on the amount of income you want. Please note that technically, this is actually a drawdown contract but looks like an annuity.
- Flexi-access drawdown – this allows you to access your pension fund in a flexible way using it like a bank account and taking occasional or regular withdrawals.