Retirement options explained
Conventional annuity rates are currently amongst the lowest ever. Apart from interest rates, longevity has a marked effect with suggestions that the 65-year-old man will live a further 24 years on average and one in two men will live a beyond 90.
What dangers for annuity purchases?
The purchase of annuity is a once only option. Once you have used your pension fund to buy your annuity there is no going back. Therefore it is very important that you consider all the options available.
The simplest option is to buy a life time annuity, sometimes called a conventional annuity. However although this provides the simplest income with little investment risk, there are a lot of options to consider.
In addition to the conventional annuity, a providers have sought to give better value to the purchasers of pension annuities and is now possible to take out an investment linked annuity which aims to provide growth in income from the growth of the underlying assets in the annuity fund, temporary annuities linked with drawdown and the use of annuities as a phased annuity purchase from a drawdown pension fund.
In addition to these options, then each type of annuity you will have the option where available to purchase an annuity for your spouse continue on your death, inflation protection and provision of a guaranteed payment period.
Most important option available, which has been therefore many years but is now being promoted better in company retirement paperwork is the Open Market Option. This means that rather than simply take the annuity option provided by your pension company, you are able to look in the market for the best rate available for you and move your pension funds to that annuity provider. Very often pension companies do not provide the best annuities and a much better income could be provided by using this option.
What dangers for annuity purchases?
A significant danger is that the annuity will not be set up correctly the first instance. Therefore it is important to consider advice regarding this once-in-a-lifetime purchase. By doing this you could ensure that your wife receives an income on your death or that your income will pay in full for a period of up to 10 years even if you are unfortunate to die it during that period.
However the biggest danger currently is inflation. At an average of 2.9% over the last few years, the value of capital and income will be eroded over 50% over the 24 years the 65-year-old man is expected to live. Inflation for those in retirement may well be higher because of the emphasis on the purchase of food and fuel.
Many annuities are bought without inflation proofing. This will mean that those retirees will see a reduction in the purchasing power of their income over time however the option to buy an increasing income is an unpalatable one due to the low level of starting income.
However, buying a level conventional annuity provides a higher income in the early years. An income purchased with a 3% inflation proofing will take 13 years to exceed that of a level annuity.
An annuity providing 5% inflation proofing will take 14 years to exceed that provided by the level annuity, therefore although a level annuity may seem to provide little protection terms of inflation, the time lag is quite long.
The most important issue regarding an annuity is the time it takes to simply receive a return of capital. For a level annuity it will take approximately 16 years to receive the full pension fund back in income. For escalating annuities and if a guarantee or spouses pension are incorporated into the rate, it will take longer to reach this break-even point.
The most marked improvement in rates is those provided due to health and lifestyle.
I simply taking account of smoking, the rate of income can be improved by 5 1/2%. By taking into account smoking and Type II Diabetes, the improvement is 23%.
This highlights the advantage of making full declarations as far as health and lifestyle is concerned. If an annuity purchase has valid health lifestyle issues the improvement in their income can be quite significant. This type of annuity is as various names but those taking account of lifestyle issues are called enhanced annuities and those for health issues are impaired life annuities.
This article does not take account of the drawdown option which is available to those retirees who have significant pension funds and understand the risks involved in drawing from the pension fund that continues to be invested in the investment markets.