Buying an Annuity
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Annuities are a way of turning your retirement savings into a regular income. You pay a lump sum to an insurance company and the insurance company will make regular payments to you in return, usually monthly. These payments are a fixed amount and will continue for a set number of years, or until you die, depending on the type of annuity.
The value of the annuity will depend on several factors including:
- Your age
- Current interest rates
- The value of your pension fund
- The type of annuity you choose
- The insurance company from whom you purchase the annuity
- The guaranteed period you choose
Advantages
The main advantage is that an annuity provides a steady, regular income, making budgeting easier during your retirement. It also removes the need for you to invest and manage your retirement savings which can become difficult if your physical or mental health deteriorates later in life. The income level will not fall with the exception of profit and unit linked annuities.
It is a straightforward procedure to buy an annuity with minimum paperwork and no ongoing reviews. Once established, there are no additional charges and nothing further for you to do and, if you wish, you can receive all your tax free cash lump sum at the start.
If you buy an annuity that lasts until you die, you also get the security of knowing that your money won’t run out. The insurance company will keep paying even if you live for longer than anticipated. However, the size of the regular payout may not eb as large if you buy a lifetime annuity, as opposed to one which lasts for a fixed amount of years.
Disadvantages
It is important to note that depending on the type of annuity you buy, the regular payments may stop when you die. If you die early in retirement, the insurance company may get to keep a substantial amount of your money. Some insurance companies try to reduce this risk by offering a guaranteed payout period. That means if you die early the annuity will continue to be paid to your estate. However, you do pay a ‘price’ for this by getting a lower amount for each year whilst you are still alive. Whether you think that ‘price’ worth paying depends on how you regard your financial obligation to any dependants or to the people you have chosen to leave your money to after you die.
Your circumstances may also change in retirement and it’s important to remember that annuities aren’t flexible. Once you have purchased it, you cannot alter it any way, e.g. adding a spouse’s pension.
The annuity could also provide poor value for money if rates are low when you retire which could erode the value of the fixed payout. You also no longer have a large chunk of money for big purchases so if you spend all of your retirement savings on an annuity, you will decrease your flexibility to cope with unexpected expenses.
There are many different types of annuities you could consider including conventional annuities, with profits and unit linked annuities, impaired life annuities and market segmentation annuities.
Annuity rates are based on long term gilt rates and therefore influenced by interest rates. With interest rates at their current level, annuity rates are currently at their lowest ever level and generally will only ever increase if it is anticipated that long term interest rates will also increase.
Before you buy an annuity you should check it out carefully. Talk to other retirees about their experiences and seek advice from an Independent Financial Advisor.
