Think carefully before buying an annuity

The idea of an annuity is simple and attractive. You save during your working life. You accumulate a pot of cash. When you retire, you take that cash to an insurance company and swap it for a guaranteed stream of income (the annuity). This will be paid to you every year or month until you die.

Unfortunately, the system isn’t working. It is, as The Sunday Times points out, plagued by poor rates (you have to live to 90 on average just to get repaid your own money) and the problem is compounded by “bad practice and unfair regulations”.

Insurers don’t make it clear to retirees just how many options they have when they come to take their pension. As a result, 40% of us fail to shop around for the best annuity. At the same time costs and commissions are horribly unclear – online brokers look free, but they really aren’t.

Policies aren’t individual enough (everyone has a different predicted lifespan) and all too many people neglect the needs of their families when getting one – very few men choose a policy that will keep paying out to their wife on their death. It all needs “urgent reform”.

So what is a retiree to do? If you want an annuity, the only answer is to get the best one possible. Shop around, look at all the options, reveal every health problem you can (the sicker you are, the more you’ll get) and perhaps even take proper advice (see www.pick-a.org for a list of financial advisers who can help).

However, your best bet may be to do as the wealthy already do, and go for income drawdown. There’s no longer any requirement to buy an annuity. Instead you can keep your pension invested and choose the income you want to take via income drawdown.

How high an income? That depends. If you can prove you have £20,000-a-year worth of pension, you can take what you like. If, like most of us, you can’t, the amount is capped at 120% of the equivalent annuity rate (which tells you what the authorities think of annuity rates).

There’s more. Drawdown isn’t a commitment in the same way that an annuity is: change your mind later and you can take the annuity route instead.

Finally, you can leave anything left over on your death to whomever you like. That’s not the case with an annuity – even if you die a week after taking one out, your pot is lost to the insurance company.

I am sure the insurers can come up with a few good reasons why one should have an annuity, not a drawdown deal – the fact that you have to take serious investment risks is likely to be one of them – but add it all up and for most people drawdown has to be worth proper consideration.

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