traditional annuity, you pay the money in your pension pot to an
insurance company in exchange for a guaranteed income for the
rest of your life. After your death, the income ceases and the
insurance company keeps the balance (if any) of the initial
purchase an annuity based on single or joint lives. A so-called
‘reversionary annuity’ is also available, in which the pension
is payable in full for the lifetime of the annuitant and then on
their death a reduced pension will be payable to their
Annuities offer a number of
benefits over other kinds of retirement options, which are
specially relevant for those who are not able, or indeed
willing, to take any risks with all or a portion of their
For example, annuities can offer:
– With an immediate lifetime annuity contract, you are
guaranteed periodic payments for as long as you live. The "risk"
of you living a long and happy life is thus borne by the
insurance company providing the annuity.
The major limit to the size of
your periodic annuity payment is the amount of money you have to
purchase an annuity. |Remember though, that generally speaking,
the older you are when you but the annuity, the larger your
monthly payments will be for any given annuity price.
– You can customize annuities to ensure that your monthly payout
will keep pace with the cost of living. This is critically
important because inflation can have a devastating effect on
your assets. The downside of added-on inflation protection is
that it can be fiendishly expensive and either make a big
increase in the initial annuity costs or provide a significantly
lower payout from the start of the annuity period.
In summary, an annuity can be a
sensible way to give you ‘peace of mind’ and ensure that you
receive a known sum each month for the rest of your life
irrespectively of how long you live.
Despite these advantages of
annuities, they do have some significant limitations. The prime
problem is that they are quite Inflexible and once you
have purchased an annuity contract your capital is gone for good
and you no longer have access to the money.
Another problem is their price. As discussed elsewhere on this
site (you can follow this LINK), it is debatable whether
or not annuities offer decent value for money at the moment or
simply have become too expensive for their worth.
You should remember that part of the money you receive from an
annuity in fact is your won money that you paid back to you
little by little.
So, if you buy an annuity for £100,000 and receive £5,000 a year
it will effectively be your own money that you get back
without any interest for the first 20 years! Only after that
time will you actually receive anything more than you would have
got by simply leaving the money ‘under’ the proverbial mattress.
And, you would have had the option to access your money it or
when you wanted (e.g. for unforeseen expenses etc.).
concept of OMO should briefly be
explained. OMO is an acronym for Open Market Option.
In the past it was common practice when
approaching retirement, that you received a letter from you
pension scheme provider, simply stating that you could get your
25% cash-free lump-sum and by signing the enclosed forms they
would purchase an annuity on your behalf.
The problem with this arrangement was (and still
is, in many cases) that the pension provider has absolutely no
interest in your welfare or whether or not you starve to death
in old age. Their only interest is, within certain limits, to
make as much profit as possible, so they will most likely chose
the annuity provider that pays them the largest commission
irrespective of whether or not it is the best deal for you.
To try to stop this ‘malpractice’ it has now
been demanded by law that annuitants must be offered the
opportunity to ‘shop-around’ and try to find the best deal
available to them before purchasing an annuity.
The intention with the OMO option is a
good one but in practice it may not be that easy for a
non-expert to evaluate all the various annuity option there
currently are available on the market – at a time where there
may be many other urgent matters to consider. So, be wary…
Consulting a good independent financial
adviser could add £1000s to your annual retirement income over
the next many years. You should however beware of tempting
adverts offering FREE advice on selecting the
right annuity and make sure that you read the small print as
many of these ‘kind’ offers are made by people who still
directly (or indirectly) may have a financial interest in
recommending their own annuity, or one from which they receive
some form of commission or ‘bonus’.
Whatever view one has on lifetime annuities one
thing is certain: once they are bought, that is it – you are
stuck with them for the rest of your life and you can not
change your mind. So, it is rather important to get it right
first time, as there will not be a second option!