Planning for Retirement – Part 1

For most Britons in their twenties or thirties now, retirement seems like a distant proposition that can wait.

Oh, there’s still time to think about what one would do in their sixties. Isn’t there?

Not quite.

Ineffective retirement planning or the complete lack of it can leave you in the doldrums without enough income to sustain your current lifestyle.

It is estimated that more than half of the people in the UK are not saving enough or not saving at all, in order to live the kind of life they expect in the golden years.

This brings us to the most important question.

How much income do you need to maintain or upgrade your current lifestyle during retirement?

Understanding Retirement

Before calculating one’s income, it is important to understand, that retirement may not necessarily be three decades away anymore.

Many people wish to retire earlier while they still have good health, to enjoy travel and other leisure activities.

Others may wish to continue working beyond state pension age.

The first option leaves you with a risk of having a smaller state pension pot when you retire.

The second allows you the luxury of delaying drawing your state pension which means, you retire with a bigger amount.

While travel and leisure seem like an attractive part of retirement life, it is only prominent in the initial years. One needs to account and plan for healthcare costs, during the later stages of life.

All this information may seem overwhelming but it is not that difficult to ensure that you are not left cash-strapped during your golden years.

Here’s an easy-to-understand decade-by-decade guide on how to plan for your retirement income.

The 20s

The 20s are a period of turmoil in a young person’s life and there are quite a few bumps to manoeuvre. So, at this stage, your main goal should be to pay off debts if any and begin saving, no matter how paltry the sum may seem.

  • Goal 1 – Clear Debts
  • Goal 2 – Start Saving
  • Goal 3 (Optional) – Start an ISA

Having said that, this age is also perfect to start your retirement plan and one of the best ways to do it is to start a tax-free ISA. You have flexible access to the money if and when, you do need it. You are building a financial resource for the future and yes, it also allows you to make ‘savings’, a habit.

The 30s

With the 30s come new responsibilities and new challenges. You may plan to get married, buy a house or start a family. Financially, you need to play your cards right in this decade. So sit down with a pen and a piece of paper and reassess your finances.

  • Do you have expensive unsecured loans like credit cards?
  • Do you have other debts like student loans?
  • Are you planning to buy a house soon?
  • Are you saving for a contingency fund?

Once you have a clear picture of your financial outgoings, you should execute a plan towards reducing it. Work on clearing off debts first. Once you are debt free, it is time to start exploring your retirement options.

Your company may have a pension scheme that you can enrol in. Explore your options when it comes to pension schemes. The default one may not be your only choice. You can take more risks at this stage. Consider investing in shares.

The 40s 

The 40’s are usually a great time financially. You have pay raises, bonuses, your debts are cleared off and you can now start thinking about dedicating a significant amount towards your retirement income.

Yes, this is a critical period for your retirement savings. What was an option to be considered two decades ago, now becomes a crucial necessity.

Ideally, you should have some sort of retirement savings by now. But if for some reason you do not, then you are not alone. Many people start in their forties and still end up with a sizeable retirement pot. Only, it may take more effort. As Albert Einstein once famously quoted, ‘Compound Interest is the eighth wonder of the world’. Start early and you will need to save less.

Your goals during this decade should be to:

  • Dedicate more money towards retirement savings
  • Add to your ISA
  • Start saving if you still haven’t started

Do read the second part of this article to get information on retirement planning in your fifties and sixties, the years that will lead up to your retirement.

How to Select a Financial Advisor

There is such an abundance of information about pensions and retirement online that retirees can make the mistake of trying to cut corners and making crucial financial decisions themselves.

If one thinks closely about the implications that such a decision may have in the next few years, the thought can be scary.

One small mistake while buying an annuity or while choosing an investment fund, can virtually change the way your life unfolds in the twilight years.

SEE ALSO: What is an Annuity?

All those years of planning, saving, and preparation can be undone in minutes.

That’s why most financial experts and even the government encourage you to seek independent financial advice before you make decisions about your pension.

It is not very expensive, and the information and advice you receive can be very well worth it. In fact, you should consider it as an investment in its own right.

How to find financial advisors

One of the easiest ways to find a financial advisor is to ask for recommendations from your colleagues or friends who may have hired their services.

However, the catch is that it may not always be possible to gauge the quality of the advice provided that a few years pass.

There are other public resources which can be a valuable source of impartial information about Independent Financial advisers who are regulated by the Financial Conduct Authority (FCA). Here are some of them.

  1. The Unbiased Web Directory (www.unbiased.co.uk) lets you search for a financial advisor close to you by entering your postcode
  2. Vouched (VouchedFor.co.uk) is a review based website that provides ratings and reviews written by genuine clients of various financial advisors. It is a good resource to analyze the services of financial advisors.
  3. The FCA (The Financial Conduct Authority) register allows you to check and know if a financial adviser you selected is an authorized one

What should you look for

Financial advisors come in all shapes and sizes and have varied areas of expertise.

Since you are looking for advice regarding retirement income, pensions, and annuities, you should look for an adviser who is skilled and qualified in those areas.

  • Check if they are qualified. Although all Independent Financial Advisers are required to be qualified to a certain minimum level (Ofqual accredited level 4 qualification), any additional qualifications will be a plus.
  • Check their expertise. A financial adviser who has been around for the last few years will certainly be a better choice than someone who has recently started their practice.
  • Ask for references to see if their clientele has mostly been people who had similar requirements as yours. A diverse clientele does not necessarily mean that they cannot provide you with good advice.
  • Check the fees beforehand. As per the RDR – Retail Distribution Review dated 31st Dec 2012, you can choose to pay fees upfront for the services, or you can choose to pay them a commission from the amount you invest in a product that they recommend. But do not slump for the first quote you receive. Get quotes from multiple financial advisors.
  • Ask if they are an independent adviser who will be able to provide you with impartial advice and offer a broad range of investment options. If the adviser only offers a limited number of investment options, then they may be a ‘restricted’ advisor.
  • Ask if you will be provided on-going advice if necessary and what it will cost you.
  • Look for advisers who agree to meet you face-to-face, free of charge. Usually, a direct meeting is a better way to understand if you are dealing with the right person.

The Preparation

If you have selected a financial adviser, then the next step is to ensure that you prepare well for the meeting. They will first try to get a clear picture of your investments and if applicable, that of your partner or spouse.

So prepare a list of all relevant details like your assets, liabilities, existing policies, private pension plans, investments, power of attorneys, wills, employment pension schemes, payslips, national insurance number and any other information which you think may be relevant.

You may also look at our Complete Pensions FAQ.

Understanding State Pensions

The State Pension is a fixed monthly income paid by the Government of UK to people who have attained the State Pension Age.

When clubbed with personal or employer pensions, it can be a valuable part of your retirement income.

It is funded by the National Insurance (NI) Contributions.

Employed people have to make mandatory contributions towards National Insurance throughout their working life.

On the contrary, if you are unemployed, disabled, or are caring for a child, then you will be credited by the Government as having contributed towards NI so that you receive basic State Pension.

Along with Basic State Pension, you may also be eligible for Additional State Pension or Graduated Retirement Benefit, depending on your earnings and subsequently, your contributions towards NI.

State Pension Age

The SPA or State Pension Age is the earliest age at which you can claim your State Pension. It depends on when you were born.

Significant changes are being made to State Pension Ages since April 2010.

The current SPA is 65 for men born before 6 October 1953 and has been between 62 and 65 for women. As of today, the SPA for Women is 62 ½. It will reach 65 for women too by 2018, and there are plans to increase it further for both men and women.

After 2018, the state pension age will be reviewed every five years and will be linked to the average life expectancy at that time.

The Two Parts of State Pensions 

There are two parts in the State Pension which are ‘The Basic State Pension’ and ‘The Additional State Pension’.

Basic State Pension: Almost every citizen of UK qualifies for a basic state pension. The amount you may receive depends on the number of qualifying years of National Insurance contributions. To be eligible, you must have made or been credited with 30 years of NI contributions. If you have lesser number of qualifying years, then the amount you receive will reduce. The basic state pension payout is £115.95 a week in 2015/16. If your spouse or partner has also built up State Pension, then you may receive double this amount which amounts to £231.90 a week. On the other hand, if your partner has not built up State Pension, they might still be able to claim it on the basis of your records (In some cases). People whose income is below a certain level can claim Pension credit which will boost their weekly state pension.

Additional State Pension: Additional State Pension or State Earnings Related Pension Scheme (SERPS) is an additional pension amount that you may qualify for depending on your contributions. In the year 2014/15, you could claim a maximum amount of £163 a week on top of your basic State Pension payout.

The New Flat Rate Pension 

From April 5, 2016, a new flat-rate pension will replace both Basic State Pension and Additional State Pension. At least ten years of contributions to NI will be mandatory for people to be eligible for any type of pension. People who have 35 years of NI contributions will receive a flat amount of £150 a week. The amount may increase if you have contributed towards an additional state pension.

The new reforms will benefit self-employed citizens who currently do not qualify for a second state pension.

Claiming your State Pension

Once you reach your SPA, you will have to claim your state pension. Ideally, you will be contacted by the Pension Service four months before you reach the SPA. If you have not been contacted at least three months before your birthday, then you can do one of the following:

  1. You can call the Pension Service on 0800 731 7898
  2. You can visit www.gov.uk/state-pension/howto-claim to download a claim form
  3. You can make a claim online at www.gov.uk/claim-state-pension-online (The government Gateway User ID and Activation Code will arrive in Post in about Seven Days from the date of registration)

You can choose to claim your state pension when you reach the SPA, or you can defer it or delay it which means you will be eligible for a higher amount when you eventually claim it 

If you still have questions in mind, you may look at our Complete Pensions FAQ

 

Options For Using Your Pension Pot

Thanks to the sweeping new pension reforms introduced in April 2015, you now have more flexibility than ever to access your pension pot.

Yes, you can choose from multiple options when it comes to accessing the funds in your pension and even choose a combination of options.

So if you are 55 years of age or have a protected retirement age and are legally entitled to your pension funds, then you now have complete control over how and when you choose to access your pension.

But irrespective of whether you plan to continue working, reduce the number of working hours or to retire fully, it is important that you plan wisely and choose the right option or combination that will give you and your dependants a stable income throughout your golden years.

Keep the Pension Pot Untouched

If you are one of the smart ones who started saving early for your retirement and has a supplementary source of income thanks to healthy investments, then you may choose to delay accessing your pension pot.

This applies to you even if you wish to continue working and have a stable monthly income at this point in time.

Delaying access to your pension pot has its advantages. Your Pot will continue to attract tax relief and will grow over time, providing you with a potentially higher income when you eventually access it.

You may need to review your investment choices though, especially if you are close to retiring. Moving the investments to safer investment choices is the expert recommended option.

Do check with your pension provider if there are any restrictions or charges if you delay your retirement date.

RELATED: How to Identify a Pension Scammer

Buy an Annuity

A quarter of your pension pot can be taken as a tax-free cash lump sum. The rest can be used to buy an annuity which will provide you with a monthly income for the rest of your life.

There are two different types of Annuities.

An annuity can also be used to set up a lifetime income for a dependent person or a beneficiary after your death.

Flexi-Access Drawdown

This is one of the newer ways of accessing your pension funds to create a monthly income.

Once again, you can choose to take an amount (25% or whatever you allocate for drawdown) of your pension pot as a tax-free cash lump sum and reinvest the rest of the amount into funds.

You can set your desired income level, and it can be altered or adjusted based on how well your investments perform.

Unlike an annuity, Flexi-Access Drawdown does not give you access to a lifetime guaranteed income. Also, your investments need to be managed with care.

From choosing a variety of investment options (Low and high risk) to using the remainder of the funds like a bank account and making periodic withdrawals, Flexi-access drawdown has its advantages.

Withdrawing Cash Sums when you need it

If you have an urgent requirement for cash, then you can make withdrawals from your pension pot. Apart from the first quarter which is tax-free, every withdrawal may incur charges and will be treated as taxable income.

There may also be limits to the number of withdrawals you can make each year.

Cash-in the entire pot 

The last option is to cash-in your entire pension pot which is considered to be an extremely risky option.

25% of the pot will be tax-free while the remainder will be taxed at your highest rate.

Here are some of the obvious risks of cashing out your entire pension pot.

  • No regular income for you or your dependant
  • Chances of incurring a huge tax bill
  • You may exhaust the entire cash pot
  • You will be left with no income during the later stages of your retirement

If you plan to cash-in your entire pension pot, then we recommend that you get professional financial advice before you do so.

If you still have questions in mind, you may look at our Complete Pensions FAQ.

The Complete Pensions FAQ

Q. What are the different types of pension plans?

A. There’s a variety of different pension arrangements that you can choose from. Some of them are State Pension, Private Pension, Workplace or Company Pension, Final Salary Pension, Stakeholder Pension and SIPP.

Q. What is the State Pension?

A. The State Pension is a government initiative that allows every citizen of UK to receive a retirement income once they reach State Pension Age. It is based on the number of qualifying years of National Insurance Contributions made over a person’s working life or the number of years that the person has been credited with, by the government.

Q. How much will I receive as State Pension?

A. The basic state pension payout for the financial year 2015/16 is £115.95 a week for a single person. If you and your spouse or civil partner, both have accumulated NI contributions or credits, then you may be eligible to receive double this amount a week. Additionally, you may also qualify for additional state pension if you were employed. However, from April 2016, the existing state pension slabs will be replaced by a flat rate state pension of £148 a week.

Q. What is a Private Pension Plan?

A. Private or Individual Pension Plans are a private form of tax-efficient retirement saving that you can set up. It is not connected to your workplace pension or your employment status. It gives you greater flexibility over your funds and lets you choose how and where to invest your retirement funds.

Q. What are the types of Private Pension Plans?

A. There are many different types of Private Pension Plans. Some of them are self-invested personal pensions (SIPPs) and group personal pensions (GPPs).

Q. What is an SIPP?

A. Self Invested Personal Plan, or an SIPP is a specialised type of pension plan which gives you greater flexibility on your investments. They can be used to consolidate multiple pension plans and manage them efficiently. An SIPP lets you choose from a gamut of investment options like shares, property and funds. However, since you will be making most of the investment decisions, the associated risk with an SIPP is higher.

Q. What is GPP?

A. GPP or Group Personal Pension is a defined contribution plan that will be set up by your employer and will be run by a pension provider. It will have multiple members who will contribute towards the pension pot which can be converted to an income at the time of your retirement. A GPP usually has a broader choice of investments.

Q. What is an employer/company pension scheme?

A. Employer Pension Scheme is a type of pension scheme set up by companies for their staff. There are two main types of employer pension schemes, final salary and money purchase. Employers are obliged to make contributions towards these pension schemes and hence, they are considered more beneficial than other forms of pension plans.

Q. What is a final salary pension scheme?

A. Final Salary Pension is a type of employer pension plan that is based on the number of years of enrolment in the scheme and your final earnings. The rate of accrual and the benefits which are taken from the pension pot may affect the pension that you receive in this type of plan.

Q. What is a money purchase pension scheme?

A. Money Purchase or Defined Contribution Scheme is a type of employer pension plan in which you make contributions each month towards your pension pot. The amount of contributions made, the annuity rates, returns on your investment and charges applicable at the time when you take benefits from the pot, will determine the amount of pension you receive each month.

Q. Is there a limit to the number of Pension Plans I can invest in?

A. While there are no limits to the number of plans that you can invest in, there may be charges applicable. So, it is recommended that you seek professional financial advice before investing in more than one pension scheme.

RELATED: How to Identify a Pension Scammer

Guide to Investment-Linked Annuities

With all the hoopla surrounding the new pension freedom reform and the way it has changed in which a retiree can utilise their pension pot, the dilemma has only increased.

Should one utilise the new flexible income drawdown option or should one continue down the trodden road and buy an annuity?

The only reason why annuities are so popular is that people prefer the long-term stability that a fixed monthly income can provide them with.

To add to this, there is a guarantee that the income will be paid for the rest of the lifetime even if the annuitant lives to be a centenarian.

The catch is that annuity rates are not the best and there is a lot of shopping around to do. To add to this, inflation will keep eroding the value of your fixed monthly income.

In such a circumstance, one must consider investment-linked annuities which offer the best of both worlds.

What is an investment-linked annuity? 

An investment-linked annuity provides you with a guaranteed fixed monthly income (lower than a basic lifetime annuity). The upside is that this income can increase depending on the value of investments like stocks and shares, but will never decrease below the guaranteed amount. This will be paid until your death.

So, essentially, you will receive a fixed monthly amount which will either be more than the minimum guaranteed amount or equal to it for the rest of your lifetime.

There are two types of Investment-Linked Annuities:

  1. With-Profits Annuity: Your pension pot will be invested in the With-profits fund by the annuity provider. The with-profits fund is an investment pool that is usually invested in a broad range of options like shares, cash, bonds and property.
  2. Unit-Linked Annuity: While it is very similar to a with-profits annuity, a unit-linked annuity gives you more control over your investments. You can choose your investment assets, and your income will be dependent on the performance of these units.

Features you can choose

Similar to Lifetime Annuities, you can choose from varied features in an Investment Linked Annuity. These should be according to your current financial circumstance and your future cash-flow requirement.

  • Opt for a Joint-life annuity if you have a dependent spouse or partner (Also called Widow’s Pension)
  • Choose a guarantee period (five or ten) years which may increase the minimum guaranteed payment
  • Select Value Protection wherein any person nominated by you will receive the unused value of your pension pot in the event of your death
  • Opt for enhanced annuity if you are in poor health or have a shorter life expectancy

To get the best rates and features, it is recommended that you shop around for your annuity.

Pros and cons

Retiree’s usually shy away from investment-linked annuities due to the perceived fear of risk. A unit-linked annuity, for example, invests mainly in equities which are usually considered a risky proposition, especially if you are nearing retirement.

On the other hand, a lifetime annuity offers a sense of safety by providing a fixed lifetime income without revealing the fact that the value of this income will reduce with time.

What are the pros and cons of an investment-linked annuity?

Should you opt for it?

Pros

  • The With-Profits annuity depends on the provider’s fund value. If this increases, your monthly income can increase significantly.
  • You can customise the initial income to suit your current circumstances by anticipating the rate of return on the investments.
  • If you are planning to continue working or have other income sources, you can opt for a lower monthly income initially which can potentially increase your income in the later stages of retirement depending on how your investments perform.

Cons 

  • The value of your annuity provider’s funds may fall at any time. This will reflect directly on your monthly income.
  • Specialized Investment-linked annuities have higher charges as compared to basic lifetime annuities. The higher fees can reduce your monthly income during retirement.

Irrespective of what type of annuity you decide to buy, Finance.co.uk recommends that you seek independent professional advice.

You can also use the free guidance provided by the government-backed Pension Wise service.

Shopping For The Best Annuity

Despite living in the age of the internet, finding the best deal can be more difficult than you think.

The problem only becomes more compound when it is a crucial decision like buying an annuity, which may well be one of the most important financial decisions you will ever make in your lifetime.

After years of saving every penny, when you are finally ready to retire, you must ensure that you get the best retirement income.

And you do not need to buy an annuity offered by your pension provider. Shopping around is your right and in this case, a necessity.

The fact is that retirees in the UK are frequently fobbed off by pension providers selling annuities. A glossy sales pitch, lack of research or pure customer lethargy can make a difference of as much as 31% according to Hargreaves Lansdown.

All said and done, how does one find the best annuity?

What are your financial goals?

If you are on a path to buy an annuity, the chances are that you have an income in mind that you would want in the years to come.

The type of annuity you choose should depend on your current financial circumstances and future financial anticipation.

An FCA accredited independent financial advisor will be the best person to guide you. Alternatively, you can also use the government-backed free Pension Wise service.

Have you made the best of your employment years and saved for the golden years? In other words, do you have any savings and funds tucked away in different nests?

  • If yes, then you may want to opt for a single life annuity which will give you with a higher income in the initial years of retirement.
  • On the contrary, if you have a dependent spouse or civil partner or a child who does not have a pension arrangement of their own, then you may want to think about their survival in the event of your death. A joint life annuity would be a better choice.
  • Is a fixed monthly income for the rest of your life enough for you? Remember that the value of this income will decrease over time due to inflation.
  • You can also choose a type of annuity where your income increases each year in line with rising prices.
  • If you are a smoker or have a health condition that could reduce your life expectancy, then you may qualify for a higher income rate through an annuity called, ‘Enhanced annuity’.

To fully understand what annuity is the best one for you, you must shop around.

What about my pension provider?

Just because you shop around for an annuity, it in no way means that you cannot sign up with your pension provider.

In fact, you can use your pension provider’s annuity quote as a point of reference while shopping around. If you get a better rate that is suited to your financial requirements, then by all means, go ahead.

On the other hand, if your pension provider offers you a ‘Guaranteed Annuity Rate’, then chances are that it will be better than what any annuity provider can give you.

That’s one scenario where you would want to stick to your pension provider.

What should you ask an annuity provider?

Ideally, an annuity provider will ask you a series of questions about your health, marital status and financial status. The annuity which they will offer to you will be based on the answers you provide them with.

You will also be provided with a personalised quote and a personalised illustration that projects why a particular annuity is the best option for you.

In 2013, the Association of British Insurers issued a new code of conduct for pension providers, under which they are bound to provide precise information to retirees about the various options they have. They should also encourage retirees to shop around so that they can get the best rates for their annuity.

If you think that the information provided to you is inconclusive, then you can choose to walk.

Alternatively, you can politely ask them to explain why their product would be the best fit for your financial circumstances.

Remember, a better retirement income might just be around the next corner. Don’t be caught with a lower rate only because you were too lazy to shop around.

Are you looking for a professional financial advisor? Read our article, ‘How to Select a Financial Advisor’ for more information.

Types of Annuities

Despite the new changes to Pension rules that came into effect in April 2015, most retirees still consider it a better choice to get a fixed income for life, also called an Annuity.

If you have considered your current financial circumstances and have decided that an annuity is the right choice for you, then it is imperative that you buy the correct type of annuity.

Yes, buying an annuity is a task that requires a fair amount of forethought because it is mostly an irreversible decision. Your choice of annuity will also determine the fixed-term income/ monthly income you and possibly, your dependants may receive for the rest of their lifetime.

There are different types of annuities and your choice should depend on your individual financial requirements.

1. Lifetime Annuity: A lifetime annuity provides you with a fixed lifetime income based on your life expectancy and current annuity rates. There are two varieties of Lifetime Annuities.

  • Basic Lifetime Annuity where you can fix your income beforehand. Once again you have the option of choosing between a single life annuity (income only for you) or joint life annuity (if you wish to nominate a beneficiary to receive the income after your death)
  • Investment Linked Annuity is a type of fluctuating income annuity where the income depends on the performance of your investments. There are two different types of Investment Linked Annuities. One is With-Profits Annuity where the income is dependent on the performance of the With-Profits funds of the Annuity Provider. The second is Unit-Linked Annuity where the income will be dependent on the funds that you choose to invest in.

In a lifetime annuity, the annuity rate will be the income that you will receive on every £ that you have accumulated in your pension pot.

2. Enhanced Annuity: An enhanced annuity is normally offered only to people who may have a shorter life expectancy. For this reason, it offers a higher annuity rate which means, a higher retirement income. Some of the criteria for eligibility include:

  • Smokers or a past history of smoking
  • A health condition or disease
  • Obesity
  • A work or employment history in a potentially hazardous environment

The insurance company may ask additional questions before you are considered eligible for an enhanced annuity.

3. Impaired Life Annuity: These are offered to people who suffer from or have suffered from any medical condition which may have reduced their life expectancy. Annuity providers seek complete information on the medical history of the annuitant and additional medical examinations may also be required.

4. Post Code Annuity: A Post Code Annuity offers you a customized annuity rate on the basis of your area of residence. People living in wealthier areas typically receive lower annuity rates as their life expectancy is considered to be higher than that of people living in poorer areas.

5. Temporary Annuity: A temporary annuity pays you an income for a fixed time period or until your death (whichever is earlier). The maximum term period for this type of annuity is five years and hence, it gives you a far higher annuity rate as compared to an equivalent lifetime annuity. You will only need to use a part of your pension pot to purchase a temporary annuity.

6. Investment Linked Annuity: This is a hybrid plan that gives you a partially guaranteed income while the rest of the income is dependent on the performance of your investments. You can select the guaranteed income you need and use a part of your pension pot to buy an annuity which would provide that. The rest of the pot will then be invested and will provide you with additional income on the basis of the returns that these investments generate. If the investments perform well, the additional income will be significant. If the markets are not performing well, then you will only receive the minimum guaranteed income.

7. Purchased Life Annuity: A purchased life annuity, also known as a PLA is a special type of annuity that can be purchased with your income or savings fund that is not part of your pension pot. You may also buy it with the 25% cash lump sum which you may draw from your pension fund. It will provide you with a fixed monthly income but has different tax implications.

8. Fixed and Increasing Life Annuity: A fixed income or a level annuity will pay you a fixed income for the rest of your lifetime. On the other hand, an increasing or escalating annuity will provide you with an ‘inflation-proof’ retirement income. An increasing life annuity has two varieties:

  • Index Linked: Your annual income will be adjusted according to a designated level of inflation which is usually based on the Consumer Price Index or the Retail Prices Index. So, if inflation rises, your income increases too. On the contrary, if inflation reduces as it happened in April 2015, your income may reduce also. But its buying power is retained no matter which way the prices go.
  • Increasing Rate: Your income will increase every year at a set rate which can be selected by you at the start of the annuity term. It can be between 0.8 to 5%. The rule of thumb is that the higher the percentage by which you want the income to increase each year, the lower the starting income will be.

 

What is an Annuity?

If you have been meticulously contributing towards a ‘defined contribution pension scheme’ all your working life, then you should have accumulated a sizeable pension pot by the time you hit 55.

The big question though is what you should do with it.

With the new Pension Freedom reforms introduced in April 2015, you can now take the entire pension pot as one or more cash lump sums receiving 25% tax benefit on each withdrawal.

The other option is to buy an Annuity.

Annuities explained 

An annuity is a product that will give you with a guaranteed retirement income for the rest of your life, in exchange for a part or whole of your retirement pot. It is like life insurance in reverse and is sold by insurance companies.

Most people take 25% of their retirement pot as a tax-free lump sum amount and use the rest to buy an annuity. However, you may also use your entire pension pot to buy one.

Annuity rates may differ from one insurance company to the other and you can either buy one from your current pension provider or shop around for the best rates.

There are many types of annuities. But the two basic types are:

  1. Lifetime Annuity: A lifetime annuity is beneficial if you have a dependent to provide for after your death. It provides you with an income while you are alive and then will pay a nominated beneficiary to be given a fixed income for the rest of their lifetime. If you nominate a dependent child, then the income will only be paid for a fixed number of years.
  2. Fixed Term Annuity: A fixed term annuity provides you with an income for a specific term period (five or ten years). You will then be paid a lump sum amount as ‘Maturity Amount’, which you can either take as cash or use to buy another retirement income product.

How much income will you get?  

Most people have this question in mind while looking to buy an annuity.

There are online Annuity Income Calculators which can give you a ballpark figure.

But the actual income that you will receive will depend on multiple factors.

Some of them are:

  • Your age when you buy the annuity
  • The amount that you have accumulated in the pension pot
  • Your health
  • Your lifestyle habits
  • Annuity rates at the time of purchase
  • The type of annuity you choose
  • The features you choose in the annuity

A large number of people in the UK do not fully explore all possible options before choosing an annuity. Hence, they end up with potentially lesser retirement income than they should receive.

Also, buy an annuity is an irreversible decision. (This will change in 2016)

Hence, it is extremely important that you shop around to find the best annuity rates and features that are suited to your current financial situation and future requirements.

Shopping for your Annuity

Your goal should be to find an annuity that provides you with the maximum income from your pension pot.

  1. Decide on the type of annuity that you wish to buy. Is it a lifetime annuity or a fixed term one?
  2. If you have any health conditions or lead an unhealthy lifestyle, then do not hide it from your pension provider since you may qualify for a higher income by opting for an enhanced annuity. This is also called an ‘Impaired Life’ annuity by some providers.
  3. Speak to your existing pension provider about an annuity and check the rate they offer. Are they offering a GAR (Guaranteed Annuity Rate)? These are extremely valuable as they provide much better rates than the ones generally available. This retirement income can be used as a point-of-reference to shop around for better deals.
  4. Compare multiple annuities for the best rates. Do check if there are any restrictions that apply.
  5. You can hire the services of an annuity broker. While a broker can give you a clear picture of the various options you have, they will not recommend any particular product.
  6. Consult a retirement expert or financial advisor to discuss your findings from the above steps. They will give you the best impartial advice after taking into account your personal and financial circumstances.

Remember, buying an annuity is a one-time decision that will impact your retirement income for life. Ensure that you seek professional advice before making a choice.

 

If you are looking for a professional financial advisor, read our article, ‘How to Select a Financial Advisor’ for more information.

What is a Pension?

If you are in your twenties, then ‘Pension’ is not a word you will frequently hear. But you will start hearing more of it as you approach your thirties and get into your forties.

Pensions, Annuities, Retirement Saving Plans and Tax Benefits! All this information can be overwhelming to the newbie.

Well, here’s the low-down on it.

A pension is a type of long-term investment plan which allows you to save money for your retirement years. But why do you need a pension? It is a tax-efficient form of savings when compared to others, and the money that you save accumulates into a pot called the ‘Pension Pot’.

When it comes to pensions, you now have more options than ever. You can either opt for a fixed income or a flexible taxed income or take out a part or whole of it as a cash lump sum.

Up to 25% of the pension pot can be taken as a tax-free cash payment.

You can sell the remainder of the pot to an insurance company in exchange for a regular fixed income that you will receive until your death. This is called an Annuity.

There are three different types of Pension schemes – your employer may run some, and others can be set up by you. And the best part is that you can invest in multiple pension schemes at the same time or even invest in ISAs or other tax saving plans.

State Pensions

The State Pension is a payment that the government will make to you on the basis of your National Insurance Record once you attain payable age.

The current eligibility age is:

65 for men born before 6th Dec 1953

Between 60 and 65 for Women born after 5 April 1950 but before 6 December 1953

Due to the Pensions Act 2008, the state pension age for men and women will increase in the future.

To be eligible for State Pension, you must have a minimum of 10 qualifying years where you make National Insurance (NI) contributions or are deemed to have paid it.

The basic state pension in the tax-year 2015-2016 is £115.95 a week. The amount you receive may differ depending on individual circumstances.

RELATED: How to Identify a Pension Scammer

Company Pensions

Company pension schemes are set up by employers for its employees. The scheme is set up under a trust and is completely managed by trustees.

Employees can choose to join a company pension scheme and make contributions towards it every year. In addition, employers also contribute towards your pension scheme selected.

There are two types of company pension schemes.

· Final Salary Scheme: The final salary scheme is also known as defined benefit pension. It is dependent on your final salary and the number of years you have enrolled in the pension scheme.

· Money Purchase Scheme: Money Purchase Scheme is also known as a defined contribution pension scheme. Typically, you and your employer may make contributions into your pension pot. The amount you contribute, returns on the investments made with the pension funds and any charges deducted when you access the pension, will determine the pension that you receive when you retire.

Each one of these schemes has their own perks to offer, and your choice should depend on your immediate and long-term financial goals.

Individual Pensions

Many financial services companies offer Individual Pension schemes which you can keep by yourself. It is not connected in any manner to your employment status.

There are multiple choices again.

Personal Pensions: This is an ideal choice for self-employed people or for those who do not have a company pension scheme. It can be taken with you even if you switch employers.

Stakeholder Pensions: Similar to personal pensions, stakeholder pensions are ideal if you are self-employed or can save only small sums of money at this point in time. Some of the benefits of stakeholder pensions are limited charges and penalty-free transfers to other pension plans.

Self-Invested Pensions: A self-invested pension scheme provides you greater control over your investments. It is usually chosen by people who have a fair amount of financial acumen and like to make their own investment decisions.

If you still have questions in mind, you may look at our Complete Pensions FAQ.