Over the course of the last year we have all heard a lot about changes to pensions, retirement and, specifically, annuities. Prior to the election this intensified as the parties vied for political points, and debate around these topics intensified. For some this has become a particularly emotive topic, but for others it leaves the question: what exactly is an annuity and why does it matter?
Annuities are designed to help mitigate the danger of outliving your savings throughout uncertain economic times. Upon retirement an annuity can be purchased in order to provide a structured income in exchange for your lifetime pension savings.
In some form or another, annuities have been around for centuries, providing an income for those who need and can afford it, and actually date back to the Roman Empire. However the modern definition has only really existed in its present form for a few decades. Today, annuities primarily protect against two main types of threat: running out of money in old age, and the risk of your invested income fluctuating as a response to unpredictable market movements.
Although there are many systems and versions currently available, typically annuities are made up of two distinct phases: accumulation, when the customer deposits any accumulated funds into an account; and distribution, when the insurance company makes payments until the death of the customer. The amount you receive through these regular payments is established via the insurer’s annuity rate, which is highly variable and there are a lot of elements and forces that can affect this.
Influencing factors
Firstly, increased human longevity means that annuity rates have begun to fall in recent years. When you consider that the world’s oldest person recently died at 117 it’s clear to see that we’re all living longer than we were 50 years ago, and so the providers have to take notice of this, meaning annuity rates have been declining in response. Another thing that affects this is the general economic climate. Interest rates are currently at an all time historic low (presently sitting at 0.5 per cent), and this means that annuity rates are also very low. If interest rates were higher when you took out your annuity, the income generated by it would also be higher.
The size of your pension pot will also affect the annuity rate you are offered – those who are able to invest larger amounts into their pension are often provided better rates on their annuity. What’s more, your age upon retirement will also have a bearing; the later you retire, the higher your annuity rate will be. If you retire earlier, your pension will have to last longer, meaning a lower income per year.
Location, health and lifestyle all also play important roles in establishing your annuity rate. Local mortality figures are used to determine this and people in poorer health are also likely to benefit from an enhanced annuity.
Finally, the type of annuity itself will also play a significant part in the amount you receive. For instance you will need to work out if your income is solely for you or for any dependants. Single life annuity will deliver an income for your lifetime only; the payments will stop when you die. Alternatively, you might be offered a slightly lower income, but with payments that continue to a dependant for a fixed term, or the rest of their life. You will also have to decide if you want an annuity that is affected by inflation or remains fixed.
Alternatives
Naturally there are alternatives to purchasing an annuity. Although this is generally regarded as the safest option you do not have to follow this course when you retire. Other possibilities include, but are not limited to:
- Drawdown – when you draw an income directly from your pension fund, as opposed to using it to purchase an annuity. This gives more flexibility, but presents a higher risk as your funds remain invested which means the value can fall.
- Deferring your annuity purchase – if you don’t need a secure income immediately upon retirement, it is possible to defer your annuity purchase for a set amount of time. However there may be penalties or charges for changing your retirement date.
- Phased retirement – rather than securing your retirement income all in one go you may set up a series of segmented annuities or drawdown arrangements by gradually drawing on your fund over a period of time.
Long way off?
You may be thinking that retirement is a long way off and that you don’t need to consider the ins and outs of annuities, however, decisions you take now, especially in regards to your pension and savings could affect the amount you later receive in retirement. Also, with Government changes constantly affecting pensions, savings and investments it pays to be aware of all of the options and understand the influencing factors.
If you are considering retiring soon, or want to plan for a secure, worry free future, it pays to seek out the advice of an Independent Financial Adviser (IFA) that has experience and understanding of your profession. The IFAs at money4dentists have over half a century’s experience exclusively advising dentists or partners of dentists at all stages of their careers and are there to help guide you through all the options available.