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Annuity Frequently Asked Questions

What are annuity rates based on?
The annuity rate is the rate the product provider uses to determine how much income they will pay you in exchange for your pension pot. If you have a pension pot of £100,000 and they exchange it for an income of £6,000 per year gross, this represents an annuity rate of 6%.

One factor determining what annuity rate you get is their estimation of your mortality - how long you will live. This means that annuity rates for women are lower than those for men (because women live longer). Annuity rates are also lower for younger people, for the same reason. Conversely, if you have health problems or you are a smoker you can get an enhanced annuity rate based on your lower life expectancy. Because people are generally living longer due to improvements in medicine, there is an ongoing downward pressure on annuity rates which is likely to continue.

The other main factor is interest rates, or more accurately long gilt yields. This is the yield or interest rate payable on long term government bonds, or 'gilts'. Gilts are used by the insurance companies as an investment to produce the required income to pay their annuitants. If the income payable from gilts is lower, then annuity rates will tend to fall.
When can I buy an annuity?
You can currently buy an annuity with your pension fund from age 55. Under current legislation you can delay your annuity purchase until age 77 at the latest. The government is however currently consulting with the industry to consider the possible increase or indeed removal of an upper age limit.
What is a guaranteed period?
As it sounds, this is a time period within which your annuity will continue to be paid, even if you die prematurely. So a 5 year guaranteed period will ensure 5 years' worth of annuity payments. After the guaranteed period ends, the annuity will still continue to pay until the annuitant dies. The possible maximum guaranteed period is 10 years. For all but the most elderly, this is a relatively inexpensive option to add to your annuity, and it will ensure that your surviving family would continue to benefit from your pension if you died prematurely. For those with no surviving family, this would be less of a priority.
What is a spouse's pension?
As it sounds, this ensures that your surviving spouse would continue to receive income from your pension after your death for the remainder of their life. Spouse's pensions are commonly selected as 50%, 66% or 100% of the original pension. The cost of a spouse's pension varies, and is dependent on the relative ages of the two annuitants. The option would tend to be cheaper on a woman's pension, (providing a spouse's pension for her husband) because statistically the husband is more likely to die first. If the spouse dies while the pension is in payment, the spouse's pension option would have been wasted and the annuity would just cease on the death of the annuitant (unless they had remarried, in which case some annuities will pay out to the new spouse). If you combine a spouse's pension and a guaranteed period and the annuitant dies within the guaranteed period, the spouse would get the full pension for the rest of that period and then the reduced spouse's pension would commence.
What is escalation?
This is a term for a pension that increases each year. The idea of this is to combat the effects of inflation and to maintain the buying power of your pension over the years. You can ask for your pension to increase in line with the Retail Price Index (RPI) each year, or it can increase at a fixed rate (3% or 5% each year are the most common). The problem with an increasing pension is that it drastically reduces your initial annuity in comparison with a level annuity. For a 3% increasing annuity, you would currently have to survive for at least 15 years before your increasing annuity had caught up with the income you would have received from a level pension.
How often will my pension be paid?
You can usually specify that your pension be paid monthly (the most popular), quarterly, half yearly or annually. The payments can be in advance (with the first payment coming immediately the annuity starts) or in arrears (monthly in arrears would start after 1 month). This has a small effect on the annuity rate offered, more so if the payments are less frequent.
What are 'Protected Rights'?
This is a part of your pension fund which has built up as a result of payments from the DWP, usually because you had 'contracted out' of the earnings-related part of the State Pension, known as S2P or SERPS. In April 2012 legislation changed which means that the rules are now the same when buying your annuity with normal or 'Non-Protected Rights' pension funds.
What is a Guaranteed Minimum Pension? (GMP)
GMP benefits arise when you have been a member of an occupational pension scheme that was contracted out of SERPS before 6 April 1997. Instead of building up a SERPS pension alongside your basic state pension, you paid reduced NI contributions and the scheme promised to provide an additional pension which was meant to mirror the State benefits you gave up. If you were in one of these schemes, or if you have transferred out of one and into a Section 32 Buyout Bond, there will usually be a Guaranteed Minimum Pension which the pension provider must honour at state retirement age, irrespective of the fund value and annuity rates at that point in time. If the fund value at retirement is insufficient to cover the GMP, then you will not be able to draw any of the fund as a tax-free lump sum.

The GMP is only guaranteed at state retirement age. If the fund is insufficient to provide the GMP before then, then you will be unable to draw benefits early.
In the case of a Section 32 Buyout Bond, you might be able to transfer into a Personal Pension prior to retirement. On transfer to a Personal Pension, GMP benefits are converted to Protected Rights. The guaranteed pension amount is lost, but it should enable the usual 25% to be drawn as a tax-free lump sum. This can be advantageous to some, but you should always take advice before giving up a guaranteed pension.

Pre 6/4/1988 GMP benefits have to provide a 50% spouse's pension. Post 6/4/1988 GMP benefits have to provide a 50% spouse's pension and also must increase in payment by the lesser of RPI and 3% per annum.
What is an enhanced annuity?
Certain people can get a better annuity rate from specialist annuity providers based on their state of health. The logic is simple - if you are in less than perfect health then you are not likely to live as long so the company will offer a better annuity rate for you. You need to provide health details, and the annuity provider will underwrite you and offer an annuity rate. This can get you a rate that is 25% or more higher than the best standard annuity. These are becoming more and more popular, because even those with minor conditions like high blood pressure, obesity, or high cholesterol can get a better rate. The downside of this for healthy annuitants is that it will tend to drive down annuity rates for them. The reason for this is that unhealthy annuitants who take a standard annuity and then die early are currently subsidising the annuity rate for healthier individuals who live longer than average. If more of the unhealthier people are segregated into enhanced annuities then this subsidy will have a lesser effect, pushing down standard annuity rates.
What are the advantages and disadvantages of Annuities?
An annuity is a very old concept that still works. You pay a lump sum of money (in this case, your pension fund) which then provides you with a very low risk, guaranteed income for the rest of your life. Even if your annuity provider went out of business, your annuity income would be protected by the FSCS (Financial Services Compensation Scheme).

This means that you have no future worries about how your investment is performing, and you can rely on that income for the rest of your life. You can also include options like guaranteed periods, increases and spouse's pensions to provide extra security for your family and protection against inflation.

Probably the main disadvantage of annuities is their inflexibility. Once you have purchased your annuity, you cannot make any alterations to it. This means that if your circumstances change in the future, you might wish you had selected different options. This is why it is important to understand all the possibilities before you make the decision.
Should I wait for annuity rates to go up?
This is a common question. There is sometimes a perception that annuity rates are at a low and that they might recover in the future, making it worthwhile to delay your annuity.

There are several factors that determine annuity rates. One major factor is longevity. As people are living for longer, annuity rates are being forced downwards. This is a trend that is likely to continue due to improvements in health and medicine. The increased popularity of enhanced annuities (for smokers and those with medical problems) will force down standard annuity rates. Finally, low interest rates and low gilt yields also put a downward pressure on annuity rates.

Standard annuity rates have been on a gradual downward trend since 1995. They do go up and down from month to month but the general pressure is downwards.

If you delay taking your annuity, you are missing out on income. You need a good reason to give up this income, especially if you have retired or are nearing retirement.
What are the alternatives to purchasing an annuity?
There are various alternative products available, such as Unsecured Pension, (more commonly known as Income Drawdown), With Profits Annuities, and Fixed-Term Annuities. The type of contract that is best suited to your needs will depend upon your circumstances, and your attitude towards risk with your retirement funds. We can discuss the best option for you during our free initial consultation, and will recommend the product that is most suitable for your needs.

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