How to get the most out of your annuity

Thanks to the compulsory annuity system operating in the UK, a good retirement here is about little more than timing. The idea behind buying an annuity is to insure that you get a guaranteed income for the rest of your life, but when you buy it makes a big difference to the income you get.

Rates have taken a nosedive in the past few weeks, for example, with most of the leading life assurers making big cuts, says Sharlene Goff in the FT. At the beginning of November, a 70-year-old man with a £100,000 pension pot would have been able to secure an annuity income of £8,138 if he'd made his deal with Norwich Union. He could now get a mere £7,944. Over all, annuity rates have fallen almost two-thirds since 1990. So what's going on?

The blame for the cuts can be put at the door of the fall in yields from gilts, which determine annuity rates, says Anne Ashworth in The Times. At the moment, pension funds desperate to ensure that they are able to meet their long-term liabilities (which are ballooning thanks to long-living pensioners) are frenzied purchasers of gilts, but their demand pushes up gilt prices which pushes down yields and hence annuity rates.

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So is there anything you can do to improve your own annuity income? There are several things to consider before you buy an annuity. For starters, note that you don't necessarily have to buy your annuity from your pension company. Scour the market for the best annuity rate and check out the rate tables on the Financial Services Authority's website (www.fsa.gov.uk).

There are various types of annuity. A single life annuity (which won't pay your spouse after your death) pays out more than a joint life annuity (which will), but it's not much use if you need to provide an income for your spouse. You also get a higher initial income from a level annuity than an escalating annuity, but the former does not keep pace with inflation and the latter does.

However, on the plus side, if you have a health problem or smoke, you should buy an impaired life annuity, which would increase your income by up to 40%. It's also worth noting that you don't have to buy an annuity until you are 75, so you might decide to delay in the hope that rates will rise (this is clearly a gamble, but many think bond prices will soon fall and yields rise, so it might not be a bad call).

If you don't want to wait until you are 75, you might at least want to wait until April, when pension changes come into force. You will then be able to buy an annuity that lasts for a limited term of say five or ten years, or to opt for a value protected annuity: this means that if by your death the total gross income you have received has not exceeded the cost of buying the annuity, your heirs will receive the difference in cash, subject to a 35% tax charge.