Saga website – different types of annuity you can buy
by Dr. Ros Altmann
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Annuity ‘jargon’ can be so confusing, and unless you understand what all the terms mean you could be stuck with the wrong annuity for the rest of your life. Consulting a financial adviser can help and remember that, whether or not you use an adviser, the insurance company will deduct between 1% and 2% ‘commission’ from your pension fund – so for a £25,000 pension fund, you will be charged £250 to £500.
Your pension company should write to you shortly before your retirement date, confirming your pension fund value and offering you a pension income – normally a ‘single life, level annuity’. This offers the highest starting rate, but may not be the best annuity for you. This article explains some basic ‘jargon’ and suggests 5 vital questions to consider before choosing your annuity.
What types of annuities are there and which is right for me?
a. Single life annuities. These only pay to the person named in the pension account and once you die the annuity payments stop. There is nothing for any partner or dependents. If you have dependents, you need to consider what they will live on after you die.
b. Joint life annuities. These will pay until you die, and then carry on paying to a partner or dependent for the rest of their life too.
c. Level annuities. These pay the same fixed amount each month for the rest of your life.
d. ‘Escalating’ or index-linked annuities. The amount paid will increase by a fixed percentage (e.g. 3% or 5%) or by the inflation rate every year. These annuities pay much less initially, but your income in later years will be higher in real terms than for level annuities. If you have no other protection against inflation, it is important to consider whether you want to an escalating annuity. Some people think the low starting income means these do not offer good value, but it is important to remember that even 3% annual inflation can halve the real value of your income within 20 years or so.
e. ‘Impaired life’ or ‘enhanced rate’ annuities. If you are a smoker, or have a history of illness, you could obtain a much higher annuity income (normally at least 30% more) because you have a shorter than average life expectancy (‘impaired life’). It is vital to consider if your health could mean a higher annuity rate for you.
f. Investment linked annuities. The pension you receive will vary depending on the performance of investment markets. Some of your pension fund stays invested, in unit trusts, bonds or with profits funds, in the hope that the eventual payouts will be higher later in your retirement, but this is not guaranteed. If you don’t want to take any investment risk, these may not suit you.
g. Income drawdown. This is not an annuity. It allows you to take some income out of your fund while leaving most of the money invested. This carries investment risk, often has high charges and must be converted to an annuity by age 75.
h. Guarantee period. Annuity companies normally offer 5-year guarantee periods, meaning if you die soon after buying the annuity, the company will still carry on paying your annuity into your estate for the remainder of the 5 years. However, you can increase to a maximum 10-year guarantee period.
The following questions could help you choose the best annuity for your own circumstances.
- Does my health history mean I may have lower than average life expectancy?
- Should I cover any dependents?
- Do I want some protection against inflation?
- What guarantee period do I want?
- Should I take any investment risk?
Having answered these, you should be better able to get the right annuity. Then shop around for the best deal.