Historically, an annuity was bought at the point of retirement with a lump sum saved into a defined contribution pension otherwise known as a ‘money purchase scheme’. Bought from an insurance company, an annuity provides a guaranteed annual retirement income for life in exchange for all or some of the pension pot that has been accrued.
Whilst annuities are no longer obligatory for someone with a defined contribution pension (as of 2015) they are still considered by many to be the best option for regular retirement income and funding later life. The state pension is not included in the calculations.
Many people do not know that annuities are also available to pay for care. These Immediate Needs Annuities (also known as Immediate Care Plans or Care Fee Annuities) are annuities that give peace of mind for life, ensuring that your parents or relatives will be looked after, and that the income to do so is guaranteed, for the rest of their life.
It can remove the worry of running out of money and can also ring fence remaining funds for inheritance.
There are 3 types of annuities:
Standard pension annuity – available to anyone but the amount received will be dependent upon age, the current price of Government bonds, health and lifestyle and postcode;
Enhanced pension annuity – In most situations, poor health or a lifestyle that could reduce your life expectancy isn’t considered beneficial, but when it comes to your pension annuity these things may secure an enhanced annuity and therefore a higher retirement income. This is because the annuity may not have to cover as many years.
Immediate Needs Annuity or Immediate Care Plan – a particular type of policy that provides a regular income in exchange for an upfront lump sum investment, designed to cover the shortfall between income and care plan costs, for the rest of the owner’s lives. This is only suitable for those receiving care.
These plans are underwritten specifically on the health of the person needing care and pay a tax-free income to a registered care provider for the rest of that person’s life. There are options for inflationary increases, capital protection, deferred plans and equity release.
It is important to understand the full implications of all the options. The levels and bases of taxation and reliefs from taxation can change at any time. The value of the tax relief depends on individual circumstances.
Key Considerations about annuities
- Not everyone gets the same deal.
- Rates vary between providers and the time at which an annuity is bought.
- Longevity is an important factor – the longer you live the lower the payments.
- Value for money is a big question.
Advantages of Annuities
- Income for the rest of the owner’s life is set.
- Usually up to 25% of the pension pot can be taken out as tax-free cash lump sum (now known as the Pension Commencement Lump Sum) before the purchase of an annuity.
- You have the security of knowing that you will never spend all your pension savings and will always have an income.
- Depending on personal circumstances, there are a number of options to include when taking out an annuity, including:
- Income for others, such as spouse or dependents
- Value protection – ability to protect a chosen percentage as a lump sum if you die without having received the full value of your pension fund.
- Protection against inflation – you can choose to increase your annuity income in line with inflation.
- Guarantee period – this ensures your annuity will be paid to next of kin/relatives for the duration of the guarantee period, even if you die early.
- Once secured, you currently cannot change the annuity, even if personal circumstances change or inflation (the cost of living) rises steeply.
- If you die relatively soon after taking out the annuity, the money used to fund its purchase cannot be returned – even if you have only received a fraction back from the annuity provider as income payments. You can choose to protect against this happening but it will mean having a smaller income from the outset.
- If you haven’t considered applying for an enhanced annuity, you might be losing out on income.
- The income you receive is dependent upon annuity rates at the time of purchase.
- By choosing to include annuity options, such as those listed in the advantages section, it will usually mean you receive a lower initial income.
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Poundbury Wealth Management LLP offers expert financial advice in investment planning, pensions, inheritance tax planning and long term care planning. Contact us at www.poundburywealth.co.uk or call 01305 266866.
Partner Tim Gallego is a member of The Society of Later Life Advisers (SOLLA), a not for profit organisation set up to meet the need of consumers, advisers and those who provide financial products and services to the later life market.
The Partner Practice represents only St. James’s Place Wealth Management plc (which is authorised and regulated by the Financial Conduct Authority) for the purpose of advising solely on the Group’s wealth management products and services, more details of which are set out on the Group’s website www.sjp.co.uk/products. The ‘St. James’s Place Partnership’ and the titles ‘Partner’ and ‘Partner Practice’ are marketing terms used to describe St. James’s Place representatives.