Making the most of your pension pot

John Greenwood says ignorance and apathy keep people from getting better retirement deals

The majority of pensioners are missing out on thousands of pounds of income for life, because they are not shopping around for the best annuity deal.

The majority of pensioners are missing out on thousands of pounds of income for life, because they are not shopping around for the best annuity deal.

Many people approaching retirement have seen their pension pots hit by poor performance in recent years. Add to that the fact that annuity rates have declined steadily for the past three decades to reflect the fact we are all now living longer.

But, while there is nothing pensioners can do about these factors, the majority are compounding the problem by missing out on annuity rates that could boost retirement income by up to 35 per cent.

Figures from the Association of British Insurers (ABI) show that just 30.9 per cent of pensioners bought an annuity from a company other than their annuity provider in the third quarter of last year.

Smokers and people who are overweight or in bad health can get substantially improved annuity rates by moving to a provider that offers enhanced annuities. Healthy non-smokers could increase their retirement income by switching to a more competitive provider when they buy their annuities.

So, with such a big difference between the annuity rates providers offer, why are so many pensioners settling for less?

Billy Burrows, the director of the specialist annuity advice firm William Burrows Annuities, says: "Many people don't realise they can significantly increase their retirement income at no cost to themselves by contacting an adviser."

What is an annuity?

An annuity is an income for life that you buy from an insurance company with the pension fund you have accumulated when you retire.

What is the "open-market option"?

This is industry jargon term used to describe your right to buy an annuity from any provider, not just the provider you have had your pension with before retirement.

I am a smoker. How much extra income can I get?

Generally, smokers get an uplift of 12.5 per cent on the best rate in the market. So a 65-year old woman with a £100,000 pension fund would receive £5,827 from Axa but could increase that to £6,692 by moving to Canada Life, whether she smoked or not. As a smoker, she could expect to improve that by a further 12.5 per cent, taking her annual income to about £7,528.

What other conditions are covered?

Annuity providers will offer improved rates, called "impaired life annuities" for a number of medical conditions known to shorten life expectancy, such as high cholesterol, diabetes, high blood pressure and heart disease. Conditions such as serious diabetes could enhance rates by about 17.5 per cent, while very ill people who have, for example, terminal cancer or serious heart conditions could see a 35 per cent uplift.

I am a healthy non-smoker. Can I still get an improved rate by shopping around?

Yes. A single 65-year-old male with a fund of £100,000 would get an annual income of £6,520 through Axa today. But by shopping around, he could increase that to £7,172 by switching to an annuity with Friends Provident - an increase of 10 per cent.

Do I need an annuity if I have a final salary pension?

No, for final salary (or defined benefit) pensions, the income is paid by the pension fund.

Do I have to spend my entire fund on an annuity?

No. You can take up to 25 per cent of your pension fund as a tax-free cash lump sum.

When should I start shopping around?

Your pension provider must give you an estimate of the value of your fund no later than six weeks before you are due to retire, but you should request a statement three months before you retire, to give yourself time to compare rates. For how to find the best rates, see the box below.

Is it worth asking an independent financial adviser (IFA) to find me the best rate?

Not all companies deal directly with consumers so a specialist IFA will be able to search the whole market for the best rate. The IFA is usually paid commission by the annuity provider which will not affect the amount you get.

I have only accumulated a small amount in my pension fund. Do I still have to buy an annuity?

Under current rules, you can take your pension fund as a lump sum if it is less than £2,500. But in April 2006 the rules are being changed, raising the limit to £15,000. This means that people with pensions of between £2,500 and £15,000 who are set to retire before April 2006 should consider postponing their retirement date until the new rules come in, to get a substantial cash lump sum rather than be forced to buy an insignificant annual income. Tax-free cash is 25 per cent, with the balance taxed as income under both the existing and incoming rules.

FINDING THE BEST RATES

* Financial Services Authority To raise awareness of the better rates available, the FSA has compiled comparative tables. At www.fsa.gov.uk/tables, you can find lists of the annuities on the market and which companies offer the best rates.

* Pension Advisory Service This is an independent organisation that provides help with consumers' pension and annuities queries. 0845 601 2923; www.opas.org.uk.

* IFA Promotion will give you a list of three IFAs in your area. 0800 085 3250; www.unbiased.co.uk.

* William Burrow Annuities Its website, www.williamburrows.com, has tables showing annuity rates on the open market.