Money: Investing for income - Use an annuity as an income boost
All investors with a personal pension must use their pension funds to buy a personal pension annuity, often known as a compulsory purchase annuity, when they retire.
Do, however, shop around for your annuity - don't allow yourself to be pressured into buying the product offered by your personal pension provider, as some insurers offer much better rates than others.
Note also that the income you get depends on the average life expectancy of someone your age. Personal pension annuities guarantee a regular income for the rest of your life. So women, who on average live longer than men, get smaller annuities. Older people, in contrast, get larger annuities.
If you have a reduced life expectancy - maybe because you suffer from a life-threatening disease, for example - look at the impaired life annuity market. Under these contracts, you get a much higher income because the provider does not expect to have to pay out for so long.
One insurer, Stalwart Assurance, even offers annuities for smokers and overweight investors. The rates are higher because such people are statistically more likely to die earlier.
However, not all annuities are aimed at pensioners. Purchase life annuities, which pay out an income until the death of the buyer, or temporary annuities which run for a set period of time, are a tax-efficient way of investing for income. An annuity bought with a pension fund is taxable like any other income at your usual rate of tax, but non-pension annuities enjoy a nifty little tax break. You are allowed to count a chunk of the annuity income you receive as "return-of-capital" rather than income. The size of this chunk is laid down by the Inland Revenue and is dependent on your age, and only the income part of the annuity is subject to tax.
Annuities can be attractive as part of an income-producing investment strategy.
"They seem to be very popular as part of a substantial portfolio, building in some guarantee," says Ronnie Lymburn, a director of The Annuity Bureau, a specialist annuity adviser. Mr Lymburn points out that with many other investments bought for income, there are no guarantees about what you will actually receive.
The problem with buying an annuity right now is that gilt yields, on which annuity rates depend, are extremely low. As a result, rates have fallen. For example, a pounds 100,000 pension fund will currently buy a healthy 65-year-old man an annual annuity of around pounds 10,300. A year ago the figure was pounds 11,200.
The income will be even smaller if you decide to buy a joint life annuity, which pays an income until both of the two people involved, normally husband and wife, die.
And remember the effect of inflation. A fixed income loses its spending power over time. Escalating annuities, where your income rises each year, usually in line with inflation, are much more expensive.
There are several annuity advisers which will help you get the best deal for your money. These include: The Annuity Bureau (0171 620 4090), Annuity Direct (0171 583 9393) and William Burrows Annuities (0171 628 3455).
q The 'Independent' and 'Independent on Sunday' are offering a free guide to buying personal pensions direct, sponsored by Eagle Star. For a copy call 0800 776666 or fill in the coupon on page 12.
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