Annuities can help you to grow old gracefully

Rates may be low, writes Angelique Ruzicka, but don't delay buying your retirement policy

Thanks to rising interest rates, people buying an annuity have had a better time of it recently. But the future is not so rosy: research from independent financial adviser (IFA) Chartwell Investment reveals that annuity rates have peaked and are due to fall over the coming months.

Thanks to rising interest rates, people buying an annuity have had a better time of it recently. But the future is not so rosy: research from independent financial adviser (IFA) Chartwell Investment reveals that annuity rates have peaked and are due to fall over the coming months.

While the decline is not expected to be dramatic, it still poses problems for pensioners as it means a lower retirement income. Given falling rates, they may be tempted to delay buying an annuity until returns are on the up again. Other pensioners are delaying their purchase because they believe this will generate more income for them, since providers offer better deals the older you get.

However, experts warn that delaying an annuity by drawing instead from your pension fund could be worse for you in the long run. Shaun McCabe, annuities manager at Chartwell, explains: "The long-term view for gilts is that they will remain stagnant, which means there will be little scope for further increases in annuity rates in the future. If this is the case, then holding off will be costly."

While it is true that an annuity will purchase a bigger income the older you are, you lose out over time. For example, a 60-year-old male with a £100,000 pension fund could buy a basic income of £6,570 a year. Wait 12 months and - assuming there has been no growth in his fund and rates remain the same - he secures an annual income of £6,720. While this is an extra £150, he will have missed out on a year's income, or £6,570.

Being older when you take your annuity may make a small difference to the income you receive, but there are other factors that could reverse this. Annuity rates are affected not only by government bonds and interest rates but by mortality rates. Breakthroughs in medical science mean we are living longer, and annuity providers take this into account, with rates coming down further.

However, if you are still intent on delaying your purchase, there are a couple of other factors you should consider. First, what will you do with the money you don't draw on? If you leave it in your pension pot, will it grow enough to make up for any income you would have received if you had taken up an annuity?

"It all depends on what you think the market will do," says Peter Quinton, managing director of the Annuity Bureau. "If you think it will go up substantially, it may be worthwhile not taking an annuity now. But history shows that any increase you could get in the markets will not overshadow the loss of income you have sustained."

Second, is your pension pot big enough for income drawdown? "If your investments perform well, it's fine, but otherwise you will eat away into your capital. Drawdown should really only be considered if you have a substantial pension pot and other forms of income," explains Mr Quinton.

So what can you do to secure a good annuity rate? According to the Annuity Bureau, only 35 per cent of pensioners make the effort to search for a better deal, with the remainder taking an annuity with the same company that provided their pension. "By shopping around you could better your income by as much as 12 per cent," says Mr Quinton.

Do your research well in advance, at least three months before you buy an annuity. Remember that, under the "open market option", you are entitled to switch your pension fund from your existing provider to another firm in order to achieve a higher annuity rate.

Shopping around will enable you to find a tailor-made annuity. For example, Norwich Union is just one provider that is increasing annuity rates for women, who usually get a worse deal than men because they tend to live longer.

Doing your own research is a good start but the best course of action is to seek independent financial advice. If you suffer from ill health or are a smoker, for example, an IFA should be able to find an annuity offering a better rate.

HOW ANNUITY POLICIES WORK

An annuity is an insurance policy paying out a guaranteed income for the rest of your life. Anyone with a personal pension or occupational money purchase scheme must buy an annuity by the age of 75.

You need invest only three-quarters of your pension pot in an annuity, as you have the option of taking up to 25 per cent as a tax-free lump sum on retirement.

Annuity rates are mainly based on the interest being paid on government bonds, also known as gilts. The bonds, in turn, are affected by the Bank of England base rate, and supply and demand. With interest rates remaining low - despite increases in the base rate this year - and gilts still in demand, annuity rates look set to be low for a while too.

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