How to get the best annuity
In this video, Ed Bowsher explains what an annuity is, how to get the best possible annuity, and points to some other ways of getting the best income in your retirement.
In recent years, many retirees have been hugely disappointed when the time has come to convert their pension pot into an annuity. That is because annuity rates have been ridiculously low.
So in this video I am going to look at how to get the highest possible income from a pension pot. Following some simple steps could boost your pension by as much as 40%!
Now, if you do not know what an annuity is, the idea is very simple: you have built up a lump sum through your working life, and you then use that lump sum to get an income that will pay out until you die. That lump sum is normally known as the pension pot. Say you have got a £100,000 pot. That pot could have come from your own contributions, or contributions from your employer or mostly likely contributions from both.
In this video I am not going to look at whether it is a good idea to save money into a pension pot. That is a really big, controversial issue, no time for that today. What I am saying is: let us assume you've got this pension pot, now we have got to look at how to get the best possible income from that pot. And the classic way to convert the pot into income is to buy an annuity.
So let's imagine you are 65 years old, you are in good health, and you do not want to provide any income for a spouse after you have died. You just want an income that will pay out every year until you die, and you are happy that that income does not rise during your retirement. So if you started out at £5,000 a year, you carry on getting £5,000 a year, each and every year until you die.
So you've got £100,000, you are 65 years old, all the other stuff I have just said, the income does not rise, at the moment the best annuity I can find today would pay out just over £6,200 a year. And that would pay out until you die.
I suspect that a lot of you are thinking that is pretty disappointing, I would agree. Sadly, annuity rates are very low these days, but that is the reality, that is the most you could get.
And if you wanted to get an annual payment that rose each year in line with inflation, the best annuity that I could find was just over £3,700 a year. So again, very disappointing.
So how can you make sure you get the best possible income from that pot? The best way for many people is probably not to buy an annuity at all, and get on a different road, and do something that is called income drawdown'.
With income drawdown, you do not buy an annuity, you set up an income drawdown scheme. You then withdraw a certain amount of money each year from the pot, and the pot stays invested in the stock market and other assets, so hopefully continues to grow, and so hopefully you will actually be able to get an annual income that might continue to grow through your retirement.
For most people, there are limits on how much money you can draw out each year. So right now, if you are around 65, get roughly £6,200 as an annuity, about the maximum you could withdraw for an income drawdown, would be £7,500 a year.
That sounds good and it is good. There are many ways Income Drawdown is a better approach than an annuity, but there is risk. There is a risk that the pot many not grow fast enough, and you will get close to running out of money before you die, the pot may whittled away.
The other downside is the charges can be quite high with drawdown. So if your pot is lower than £50,000, I would say you really should not consider drawdown. The bigger your pot, the less the charges matter, and the more appealing income drawdown becomes.
If you are considering going down that road, definitely get some professional advice from an accountant, or an IFA, but it's well worth considering.
If you decide to go for the traditional annuity solution with a guaranteed income until you die, there are two more really important tips here.
The first one is to shop around before you buy the annuity. Once you've bought the classic, traditional annuity you're done. If you have got £6,200 a year, you cannot change it. If you have bought that level annuity with the unchanged income payout, you cannot go back and change your mind. It is done for life.
You want the best possible deal when you are buying the annuity, and you do not want to make the mistake that many people make of buying an annuity from the company that managed that pension pot. A lot of people just go "all right, I've got the pension pot that company provided me with, so I will buy an annuity from them". If you do that there is a strong chance you will not get the best deal.
If you shop around through companies like Annuity Direct, you will certainly find higher annuity incomes offered to you. Typically, you could get as much as a 20% boost to your annuity compared to what you're offered by your current pension pot provider.
The other really important thing to do is if you have any medical conditions, or any lifestyle issues that might damage your health, make sure you tell the annuity providers when you apply for a quote. So obviously if you have got cancer, or any heart conditions, asthma, diabetes, tell them. If you are a smoker, if you are a heavy drinker, tell them. All of these things mean that you are more likely to die in the relatively near future. That means the annuity providers feel able to pay you a higher annual income, because they think your lifespan is going to be shorter. So do not hold back, put all that information in the application form.
Another really important thing to do is when you buy the annuity, you have the right to take 25% of the pension pot out as a tax free lump sum. So in this example, you could take out £25,000.
Firstly, it's really attractive that it is tax free. The second big advantage is that you can use that money flexibly. You can carry on investing in the stock market, or you can stick it in a bank account, either way it is money that you might leave aside, and not touch for another ten years if your annuity income is getting a bit low. Or you might decide to spend it all now, and go on a cruise, whatever takes your fancy, but make sure you do it, because it's tax-free income, unlike the annuity income, which is liable for income tax.
A final couple of tips.
Consider what I call a sort of halfway houses between annuities and income drawdown. So you could buy something called an investment-linked annuity'. With that, you get this income for life, but the size of that income may vary depending on how well the stock market has performed. You'd normally expect the stock market to perform over the long term, so it should probably give you a rise in income, but there are no guarantees.
Another option is something called a fixed-term annuity'. With that you take some of your lump sum, and you buy an annuity just for the next five years. Say you take £30,000, it will give you an annual income for the next five years of, say, £7,000, then at the end of the five years you've got the remaining £70,000, and you can then go into drawdown if you wish, or buy a traditional annuity.
By going for that fixed term annuity, you're giving yourself more flexibility, and you are postponing the day when you have to make that irrevocable decision that reflects what your retirement income will be until you die.
So that is a really quick overview of annuities, I hope you found it useful. If you are not yet at the stage where you do need to convert your pension pot to income, say if you are younger, please make sure you save as much as you can for retirement. It does not have to be through a pension, it could be through Isas, or through other investment vehicles, but just make sure you save as much as you can.
I hope you found this overview useful, I will be back with another video soon. So until then, good luck with your investing.