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Your Money > Pensions Articles > Annuities: boost your pension in one simple step
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By Richard Evans Consumer apathy is rightly condemned by all commentators on personal finance. But while sticking with a savings account that has dropped out of the best-buy tables might lose you a few pounds in interest, taking the easy option when it's time to Unless you are one of the dwindling band of employees fortunate enough to have a final-salary pension, your occupational or private pension will produce a pot of money that at some stage - usually when you retire - will be used to buy an income for life called an annuity. "It's vital to think of these two phases of your pension as two separate contracts," says Tom McPhail, the head of pensions research at Hargreaves Lansdown, the financial adviser. "The company that looks after the first phase - the accumulation of your pension savings - may not be the best one to provide your income in retirement." Fortunately, under what is called the "open market option", you are entitled to shop around for your annuity - you do not have to take the one offered by the company that managed your pension savings. Shortly before you are due to retire, your pension provider will write to you to tell you how much you have saved and the income you will get if you buy its own annuity (although it must also draw your attention to the open market option). "It is so easy to tick the box, sign the form and send it back," says Mr McPhail. "But the difference between the best and worst annuities can be 15 to 20 per cent. One top pensions provider, which manages the savings of millions of people, told me recently that it had no intention of trying to be competitive in the annuity market. "This shows how important it is to shop around for the best deal. Switching won't cost you anything except your own time - it's extraordinarily wasteful not to do this in exchange for the chance of a large increase in income for the rest of your life." Or, as Stuart Bayliss of Annuity Direct, the specialist adviser, puts it: "Getting the best annuity can be the equivalent of several more years' growth in your pension investments." Annuity rates generally have fallen sharply over the past few years, largely because of increases in life expectancy and low interest rates. In particular, insurers have been buying long-dated bonds to match their liabilities; this demand has pushed up bond prices, with the result that yields have fallen. You can shop around for the best annuity rates yourself or use an independent financial adviser. Either way it will cost you nothing; advisers are paid by commissions that are built into the price of annuities bought through either channel. "An adviser has access to certain annuity providers that don't deal directly with the public," says Mr Bayliss. "Also, they will ask about your needs and circumstances. For example, 40 per cent of those retiring are eligible for higher annuity rates because they or their partners smoke, or have reduced life expectancy for some other reason." Smokers typically receive 10 to 15 per cent more from their annuities than non-smokers, he says. Both experts cite another reason for using an adviser: pension providers' admin is notoriously slow and inefficient, they say; an adviser takes over the burden and will be familiar with the pitfalls. It is also important to consider the type of annuity you need. The majority of annuities taken out are "single-life", meaning that they will pay no income to a surviving partner when the annuitant dies. "Most pensions are in the man's name, and men tend to be outlived by their wives," says Mr McPhail. "Taking out a single-life, rather than a joint-life, annuity means that your initial income is higher, but it is storing up problems - for the surviving spouse and for society in general." Most annuities are "level" - the yearly income is fixed at the outset and does not rise or fall. The problem with this is that the real value of the income is eroded by inflation. "Your life expectancy might be 20 years when you take out your annuity," says Mr McPhail. "And 20 years' worth of inflation is hugely corrosive." You can deal with this risk by buying an inflation-protected annuity, where the income rises in line with prices, but this is very expensive - your initial income is likely to be a third less than that from a level annuity, he adds. There are other types of annuity that aim to offset the effects of inflation. Investment-linked annuities, which may be linked to with-profits or managed funds, could generate a rising income, but the annuitant is taking on some investment risk - his income could fall if markets crash or the investments are poorly managed. While with-profits investments generally have come in for a lot of criticism recently, says Mr Bayliss, they may be more appropriate for annuities. "Relying solely on a level annuity could be a bad idea because of the effects of inflation," says Mr McPhail. "Equally, it will not always be prudent to expose all of your retirement income to investment risk. So the best option may be to split your pension pot and use some of it to buy a level annuity and some to buy the inflation-protected or investment-linked variety." Those with a certain type of specialised pension plan should think twice before buying their annuity from a different provider. These are pensions that include guaranteed annuity rates (GARs), which means that the rate of return on your pension pot was fixed at the outset, when interest rates generally were significantly higher. "Pensions with GARs are still maturing," says Mr Bayliss. "Some are no good, some are excellent, paying perhaps 11 per cent for a man at 65 ." Annuity rates now are usually around 7 per cent. But GARs can be inflexible, he says; for example, they may be single-life only. "People with reduced life expectancy could also be better off switching away from a GAR. A financial adviser can check whether your pension plan includes such a guarantee and advise whether to stick with it." Useful links |
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