Annuities aren't has-beens if you hunt for the best deal
Many investors feel the 'income for life' will end up leaving them short-changed. Annie Shaw finds they could be better off than they think
Sunday 17 February 2008
Annuities aren't popular with many people putting money by for their retirement, and it's easy to see why. Quite apart from the halving in annuity rates since the early 1990s, savers fear they won't get their money's worth. As 75 per cent of their private pension pot must be turned into one of these policies by the age of 75, in return for an income for life, there is a risk they won't live to enjoy all their savings. What's more, any unused annuity funds can't be passed on to their heirs when they pass away.
But on the flipside, there is no chance the money will run out with annuities, as it could do with other savings, and industry experts dispute the contention that they represent a bad deal. "Annuities are regularly written off by investors as poor value for money, but academic studies have repeatedly shown that they deliver fair value," says Tom McPhail, head of pensions research at independent financial adviser (IFA) Hargreaves Lansdown.
And we are all living longer. The Office for National Statistics predicts that the number of centenarians will grow to a total of 40,000 by 2031.
Buying an annuity is unavoidable for most people, but being lumbered with a bad deal isn't. The amount of income paid by a policy depends on the provider, and IFAs stress the importance of exercising the open market option (OMO). With the OMO, savers take their pension pot and buy the best possible annuity from the whole range of providers, instead of simply accepting the policy offered by the insurer that managed their pension fund.
The one situation where you should stick with your original provider is if your pension contains an annuity guarantee. Some older, usually with-profits, contracts have valuable guarantees that can give you an annuity rate up to 60 per cent higher than you will find on the open market.
How much income you receive will depend on a number of factors: the size of the fund saved, prevailing annuity rates, and estimated longevity as calculated by an actuary, who will consider your age at the time of buying the annuity and your gender.
Annuities can be taken out on a joint-life basis, which means the policy will continue to provide for a spouse or civil partner. In addition, they can be designed to increase in line with prices, which can be very useful. "Inflation is the enemy of retired people because it erodes the buying power of their pensions. Once you retire, there are no more bonuses, no more overtime and no more promotions," says Kevin Pacey, head of the Bank of Scotland Annuity Service.
Of course, adding a spouse or guarantee is going to cost more. In other words, it will mean less immediate income in exchange for added benefits.
"Inflation linking currently reduces the initial pension for a 65-year-old male by 35 per cent," says Mike Fosberry at adviser Smith & Williamson.
The annuity market works by pooling risk. This means that people with high-risk lifestyles or suffering from medical conditions actually get more, because they are unlikely to live as long as the healthy.
Smokers can get what's called an "enhanced annuity", while heart disease sufferers, asthmatics, diabetics and people who have a high body mass index can buy an "impaired annuity". These can equate to an income boost of anything up to 15 per cent.
Last year, Legal & General even started offering enhanced annuities to those living in postcode areas with higher-than-average mortality rates.
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