Retirement Options

A pension annuity is used to convert capital within a pension plan into a regular guaranteed lifetime income. As you do not have to buy your pension annuity from the same insurance company that manages your pension, it makes sense to "shop around" and obtain the best pension annuity available.

Pension plans to convert to an annuity

Under current legislation you must convert your pension plans into a pension annuity before the age of 75. Pension plans include: personal pensions, stakeholder pensions, group personal pensions, executive pension plans, retirement annuity contracts, (pensions sold prior to July 1988), additional voluntary contribution schemes (AVC), free standing additional voluntary contribution (FSAVC) schemes, section 32 buyout bonds and employers pension schemes known as money purchase schemes.

All savings from these pension plans can be used, and this is known as using your open market option to obtain a higher annuity rate.

Flexibility and choice

With most types of pension you are free to choose the type of pension annuity that suits you best. After taking any tax free cash that is available you can choose to have your income paid to you monthly, or annually, level or increasing, with or without any guarantee period and on a single or joint life basis.

Protected rights annuity

This is a pension annuity that is purchased with money from an appropriate personal pension plan that has been used to contract out of SERPS or the state second tier pension, SP2. Known as protected rights, the government dictates how and when you take the benefits, and you have less choice on how this annuity is set up. You are still free to "shop around" and obtain the best pension annuity available.

Purchased life annuity

A with profit annuity links your income to the performance of the insurance company’s with profit fund. Instead of providing a known guaranteed lifetime income your actual income is linked to the annual bonus rate declared by the insurance company for the with profit fund.

Anticipated bonus rate

At the outset you choose a rate of growth you think the insurance company will achieve year on year for the with profit fund. This is called the anticipated annual bonus rate ( ABR) and you can choose a rate between 0% and 5%.

Your choice of ABR dictates your initial income and the risk you are willing to take on this income increasing or reducing in the future.

Selecting a high ABR provides a higher starting income than selecting a low ABR. However a high ABR also carries a greater risk that this income may be reduced in the future if the actual bonus rate declared is lower than the anticipated bonus rate you selected.

If the actual bonus rate declared is the same as your anticipated bonus rate your income remains the same, if it is higher then your income increases and if it is lower your income reduces.

With profit fund smoothing

With profits funds invest in a mix of shares, fixed interest securities, property and cash. This wide investment mix gives potential for investment growth but it is the way with profit funds allocate the investment returns to policyholders that is the distinguishing feature of a with profit annuity. The insurance company smooth returns by keeping back some of the profits earned during periods of strong growth to bolster returns when stock markets perform poorly. It is these smoothed returns that are paid out to you in the form of annual declared bonuses.

Minimum income guarantee

Some with profit annuity providers offer a minimum income guarantee. This means that regardless of future bonus declarations and the initial ABR your selected they guarantee an absolute underlying minimum income you will always receive. This is normally set at the same level of income that would have been paid if you had chosen an ABR of 0% at the outset of the plan.

Unit Linked Annuity

A unit linked annuity works in a similar way to a with profit annuity except your income is linked to the actual value of the underlying fund. Unit linked funds do not offer the benefits of smoothing and do not normally provide a minimum income guarantee associated with a with profit annuity. As unit linked funds are normally equity based they carry a greater risk of volatility and your income may fluctuate significantly year on year.

Some annuity providers offer an enhanced pension annuity or an impaired life annuity if you have a health problem, a long terms illness or if you are overweight or smoke. An enhanced annuity is used for minor illnesses, and an impaired life annuity is used for life threatening illnesses. Typical enhancements for a male aged 65.

Health related enhancements

Relevant health problems may include; angina, angioplasty, cancer, chronic asthma, diabetes, heart attack, high blood pressure, multiple sclerosis, parkinson’s, stroke or any other problem that threatens to reduce your lifespan. Exact enhancements are linked to individual circumstances and are available for a pension annuity and a purchased life annuity.

Smoking related enhancements

If you have smoked ten or more cigarettes per day for the last ten years you will qualify for an enhanced smoker annuity. This enhancement is only normally available for a pension annuity.

Weight related enhancements

If you have a body mass index of 25 or more you are considered overweight, if it is higher than 30 you are classified as obese. Body mass index is not an exact measurement, but if you consider yourself overweight you may qualify for an enhanced pension annuity.

Occupation and location enhancements

Certain manual and blue-collar occupations and some postal districts within the country also qualify for enhancements. Very few providers offer this enhancement and it is only currently available for a pension annuity.

Activities of daily living

Based on an individual’s ability to perform a number of set daily activities; such as washing, mobility, dressing, etc. The more help an individual needs with daily activities the higher the annuity. This enhancement is available for a pension annuity and a long term care assurance annuity (nursing home fees).

Income Drawdown

Unlike a traditional pension annuity the capital from an income drawdown plan is not used to purchase a guaranteed income. Instead the pension fund remains invested in a range of assets, and a variable income is taken directly from the pension fund. This is known as income withdrawal or income drawdown.

Investment Risk

Income drawdown avoids purchasing an annuity until as late as age 75 by leaving your pension fund invested in a range of assets. As the value of your pension fund can go down as well as up and future annuity rates could be lower than those available today, income drawdown is regarded as a higher risk to purchasing a traditional pension annuity.

Income limits

The government actuary department limit the income that can be taken from income drawdown plans. Income must be taken between the maximum and minimum limits set. The actual income you take, together with your age, health and choice of underlying investments will affect the risk associated with income drawdown.

Critical yield

The risk associated with income drawdown can be assessed by a formula known as critical yield. In simple terms the critical yield shows how much your pension fund has to grow by each year in order to provide both the income you wish to take from your plan each year and finally buy this income at you 75th birthday by way of a traditional pension annuity. In effect, the lower the critical yield, the lower the risk.

Death benefits

On your death before aged 75 the value of your pension fund, less a tax charge, can be passed to your beneficiaries. This provides greater value than a traditional pension annuity that does not allow you to pass the capital value of your fund to your beneficiaries on death.

Tax free cash

An income drawdown plan allows you to withdraw all of the tax free cash available from your pension plan and leave the remainder of your pension fund invested. This facility is unique to income drawdown and can be beneficial if you do not wish to sell the underlying assets held in your pension fund.

Phased retirement

A phased retirement plan allows you to ‘phase in’ the income you need over a number of years using a mixture of tax free cash and traditional pension annuities. Phased retirement effectively divides your overall pension plan into 1000 or more segments and treats each segment as an individual pension plan. This allows you to convert one or more segments each year into a pension annuity to provide the income required and leave the remaining segments fully invested. Phased retirement can be combined with income drawdown to provide a totaly flexible retirement income.