Annuity returns have more than halved in two decades, so the need to squeeze the most out of your pension pot is paramount "I'll have 20 Lucky Strike and an enhanced annuity please" – smoking and ill health can lead to a larger income in retirement.
Chris Ison/PA Calls to end the "pensions rip-off" are getting louder, as campaigners ramp up pressure on the industry to reform financial products bought at retirement to provide an income for life.
Each week, thousands of savers swap the pension pots they built up over their working lives for a product that provides an income in retirement, called an annuity. However, MPs and pension experts say these are inflexible and offer poor value, with proposals to refom the market including allowing pensioners to switch annuities during retirement. At present, most retirees buy an annuity and are stuck with the income it provides for the rest of their life, which can result in big losses if they make the wrong choice.
Some savers are left with little chance of living long enough to get back the sum they intially paid for the annuity, according to pensions expert Ros Altmann, adding that many are a "rip off". "For most annuity providers customers are assumed to live to at least age 90, and they often need to live beyond this age before they are being paid any more than their original pension fund," she says. "For the worst providers, the insurer still has some of their original pension fund money when the customer is over 100."
Figures published by the Association of British Insurers show that some firms are offering annuities that provide an income 30% below the best deals on the market. In recent years annuity rates have plummeted, with savings of £100,000 translating into an income of just £6,280 a year for life, compared with £13,681 two decades ago, according to the Annuity Bureau.
The Financial Conduct Authority will publish a review of the annuities market in February, and while pensioners hope for a better deal, there are other ways you can boost your retirement income.
Taking the drawdown risk At retirement you can either convert your pension into income by purchasing an annuity, or keep it invested in the stock market and draw an income from the mixture of bonds, stocks and shares you hold. This is known as income drawdown, and it is more risky than locking into an annuity because your money remains subject to stock market swings – but it is also potentially more rewarding.
Advisers agree that income drawdown works better for people with larger pension pots of around £100,000 or more because the fees are quite high, consisting broadly of ongoing charges, drawdown fees, the cost of the underlying investments and any advice charges. The income you get depends on the size of your pot and how well the investments perform. However, those with a larger pension pot are better placed to survive stock market volatility.
If you opt for income drawdown you can take a 25% tax-free cash lump sum from your total pension pot, as you can when buying an annuity. However, you can also pass on your pot to relatives when you die, unlike with a conventional annuity whereby the insurer keeps anything left over.
There are two types of drawdown: capped and flexible. The first imposes a maximum amount that can be drawn each year of about 120% of the equivalent annuity rate, while flexible drawdown has no limit, but you must have a guaranteed income of at least £20,000 a year before tax from other pension income.
If at some point you decide this option is too risky you are able to use the remaining money to buy an annuity for a guaranteed income for the rest of your life.
Smoking and ill health There are methods of boosting the income from a conventional annuity if you fit the criteria. You could opt for an enhanced or impaired annuity that pays out a greater income if, for example, you have had certain illnesses or are a smoker, as you are statistically likely to live for a shorter period. Even if you don't suffer from ill health or smoke, check this out. In the past, you used to have to be seriously ill, but now you can qualify for one of these annuities on grounds such as blood pressure, high cholesterol or being overweight.
This option could make a huge difference to your income, according to Just Retirement, which specialises in retirement payments if your life expectancy is likely to be shorter than average. "People can increase their pension income typically by 25% when they purchase an enhanced annuity, which can mean thousands of pounds extra in retirement," driector Stephen Lowe says. A 60-year-old man who has suffered a heart attack in the past could see his pension boosted by around 25% compared to the lowest standard rate.
A mix and match approach There are products that bridge the gap between conventional annuities and drawdown, such as fixed-term annuities and investment-linked annuities. The former pay an income for a fixed period of, say, five years rather than for life. "You then receive a proportion of your lump sum back to buy a lifetime annuity at a later date when, say, your health has deteriorated and you qualify for a greater income, or rates have improved," says Dean Mirfin from Key Retirement Solutions.
Alternatively, an investment-linked annuity combines the flexibility of drawdown with the fixed income from an annuity. Advisers often recommend a mix-and-match approach for those with larger pensions.
Delay buying an annuity You could leave your pension fund where it is in the hope it will rise in value. More than 50% of annuity purchases are made with pots of less than £20,000 and around 30% are less than £10,000, says Tom McPhail, head of pensions at Hargreaves Lansdown. "For these people the 'do nothing' option will have significant attractions. They may not need the extra few pounds a week that an annuity from this sum would give them, whereas leaving the money invested would give it more change to earn returns, and allow time in case the person becomes ill and qualifies for an enhanced rate, or in case annuity rates or other circumstances change."
If you pass away before age 75 the whole fund passes on to your family, tax free, but once it is annuitised the fund has gone.
When buying an annuity many people simply take the annuity offered by their pension provider, but it is vital to opt for the "open market option" to search for the best rate. Check out Which? Annuity Advisers, set up by the consumer group, and Pick A retirement specialist, which puts savers in touch with independent financial advisers and annuity brokers.
Source The Guardian
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