With the recent news that annuity rates have hit all time lows let us take a look at annuities, how they impact pensions and how the new rates affect people approaching pensions, and possible alternatives.
An annuity, also known as a lifetime annuity, is essentially an agreement made between the pension holder and an insurance company where the pension holder will give either a portion or all of their pension over to the company who will then pay it back to the holder for the final stretch of said holders life, in the form of a regular income. The annuity income can be paid out either yearly, half-yearly, quarterly or monthly.
An annuity rate is the rate at which an individual’s accumulated pension will be paid out over the years, via a defined contribution pension scheme or a money purchase. After building up their ‘pension pot’ people then exchange the funds for a guaranteed income, the rate of which is set by their pension provider.
Annuities are quite flexible, the amount you receive through them may remain the same at all times or they may have been set with annual increases, either at an agreed rate, like 4 percent a year, or the increase may be at a variable rate. An annuities value is dependent on how much money you have in the first place and the rate of annuity offered by the seller. The rate of annuity is what converts the funds into the pension. Insurers calculate annuity rates by looking at factors such as current interest rates, the individuals age, their gender, their mortality and general health. The older someone is the higher their rates will be as they will have less time to live, also a man would be offered a higher rate than a woman of the same age because the male life expectancy is lower than that of a female.
What’s happening now is that annuity rates have been in steady decline for a number of years, with an all-time new low, 6.35 percent, now being reached. The low rate means that retirees will now have less pension money then ever before. Someone with a retirement pot of £100,000 will now only receive £6,350 per year, which is £1,220 less than what they would have received two years ago, also when you buy an annuity the rate at which it is sold is the rate you are stuck with for the entire package.
One of the problems with annuities is that insurance companies constantly adjust them in line with people’s life expectancy. As people begin to live for longer insurance companies don’t want to give out more money so they reduce the rates. Another issue is that fact that insurance companies pay out on the annuity via money they themselves have earned through purchasing government gilts and bonds, as these gilts have grown in popularity so has the price been increased, leaving the insurance companies with less profit to pay out from.
At the moment people are not forced into buying an annuity until they are 75, but the new government has come out and said that they plan on changing this scheme, and making it more flexible.
If you have entered retirement and feel that you have to buy an annuity as soon as possible then the advice is to shop around, there are different annuity packages available for different types of people. For instance the cautious type could find an annuity that will protect you from inflation, and on the flipside a daring investor could find one that allows you to dabble in the stock market.
If you feel that you may wish to seek an alternative option then be aware that there are other pension plans available. The QNUPS is a new offshore pension plan that doesn’t require you to buy an annuity. For information please see our pensions and retirement section