What is more, for most people, this is not a gamble they can avoid taking. In order to convert a pension fund into an income when you come to retire, you usually have to buy an annuity. The main exception is if you belong to a company scheme where your pension is based on the value of your final salary.
Annuities involve a straight swap of capital for income. In most cases you hand over most of your pension fund, or another lump sum, to an insurer. In return, you get paid an income until you die.
If you buy an annuity today but die tomorrow, you have simply swelled the insurer's coffers to the tune of your lump sum. So to make annuities more appealing, hybrids have been created. One involves the dead person's estate receiving whatever is left of the first five years' annuity payments.
As well as hinging on how long you live, the value of your annuity depends on when you retire. Annuity rates vary considerably, in line with the rates on long-term government borrowing (gilts). The lower the rate, the lower your income.
What is more, once you have bought an annuity you cannot switch your original capital to a new one simply because rates have subsequently improved.
The bad news is that rates are still low. Despite having improved a little over the past couple of years, your income will still be around a third lower than if you had bought in May 1990, according to London-based independent adviser The Annuity Bureau. Although you can defer buying an annuity and still get an income from your pension fund, this option is generally not recommended if your pension fund is worth less than pounds 100,000.
However, there is some good news. By shopping around for the best rates on offer you could increase your income by up to 25 per cent. Take, for example, a 65-year-old man buying a pounds 100,000 annuity that will pay him a level income - a fixed amount that does not rise in line with inflation. One of the best deals currently on offer, from Canada Life, would pay him pounds 11,687 a year.
By contrast, a middle-of-the- range annuity, from Scottish Amicable, would pay him just pounds 10,464 a year. As Peter Quinton, of The Annuity Bureau, points out: "The life expectancy of a man aged 65 is just over 13 years, so the better policy could save him pounds 15,900."
As well as getting the best rate you can, it is crucial to decide what type of annuity you want. The options include a single or joint life - a policy for yourself or one that pays another named person an income after you die. But the price of this joint-life option is that you get less income to start with.
There is also the choice of level or increasing income. You can buy an "escalating" annuity, where the income increases in line with inflation or by a set amount each year. But again, this involves taking a much lower starting income. In general, if you live longer than average, an increasing income will pay off: many estimates place the point at which you gain by starting from a lower, but escalating, annual income at 13 years after retirement age.
q Free leaflets from The Annuity Bureau (0171 620 4090); Annuity Direct (0171 375 1175); and Johnstone Douglas (0800 557768).Reuse content