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.

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.

Understanding Lifetime Annuities

After years of appearing on the horizon, when retirement finally looms large, the years ahead appear like a haze.

What will retirement life be like? Where will you live?

Can you maintain the standard of living that you are so used to or will there be a drop in lifestyle?

Finally, it all comes down to how well you prepared for the twilight years.

You worked diligently to accumulate every penny that you could and built a small pot that you hope will suffice for the rest of your life.

But with inflation biting away at your savings and increased life expectancy, will your pension pot last as long as you do?

Outliving your pension fund can be a nightmare for most retirees and a lifetime annuity may be the best choice in such a scenario.

What is a lifetime annuity?

In a nutshell, it is a contract between you and an annuity provider (an insurance company) who guarantees to pay you an income for the rest of your life in exchange for a part or whole of your pension pot.

You can choose to draw up to 25% of your pension amount as a cash-free lump sum and use the remainder to buy a lifetime annuity. Alternatively, you can invest the entire pension pot in exchange for your lifetime annuity depending on your individual financial circumstances.

The rule of thumb is that the more you invest to buy an annuity, the more you will be paid every month.

There are two different types of lifetime annuities that you can select and the type you choose, along with the customizations you make, will determine your income for the rest of your life.

Basic Lifetime Annuity 

A Basic Lifetime Annuity offers a bundle of income options that you can select depending on your individual circumstances.

  • Single Life Annuity: If you have no financial dependents or if your spouse or partner has their own pension scheme to rely on, then a single life annuity should be your first choice. In this type of arrangement, you will receive a fixed income for the rest of your lifetime. The payments will stop after your death.
  • Joint Life Annuity: A joint-life annuity is ideal if you have a dependent spouse or partner who does not have a pension scheme of their own. It can also be beneficial if you have dependent children. In this type of annuity, you will receive a fixed monthly income (usually lower than a single life annuity) for the rest of your lifetime. It will then be transferred to your spouse, partner or any nominated beneficiary. In case you nominate your children, it will be paid to them until they reach the age of 23.
  • Fixed Income Annuity: A fixed income annuity will provide you with a fixed monthly income which you and the annuity provider can select beforehand. However, it will not be protected from inflation and if the prices of commodities like food increase over the years, you will be able to buy lesser with the same amount. The advantage of a fixed income annuity is that it starts off with a higher monthly income as compared to an escalating annuity.
  • Escalating Annuity: If you wish to protect your monthly income from inflation, then you can choose an escalating or increasing income annuity. There are two different options that you can choose from.
  1. A preset rate at which your income will rise every year (3 to 4%)
  2. An index-linked option in which your income will be adjusted as per the inflation. If inflation reduces and prices fall, then your income will also subsequently reduce. Alternatively, if inflation rises, then your income will also increase. This protects your monthly retirement income from inflation.
  • Guarantee Period: A monthly fixed income would be paid for a fixed term period (example 10 years) irrespective of whether the annuitant is alive or dead.

Investment-Linked Annuities

Investment-linked annuities are an apt choice if you have other fixed monthly income investments and are willing to take the risk in exchange for a higher monthly payout.

It is directly linked to the performance of your investments. If the investments perform poorly, your monthly income will reduce but not go below a minimum guaranteed amount.

On the other hand, if the investments perform well, the monthly income will increase considerably as compared to a fixed lifetime annuity.

Which should I choose?

Your choice of an annuity should be dependent on your assumptions about future cash flow, your current financial circumstances, your health, dependants if any and your attitude towards risk.               

 

 

 

What are Fixed Term Annuities?

It is estimated that after the new pension reforms, retirees opting for annuities could reduce by up to 75%.

One of the reasons for this reduction is because retirees were often locked with a low annuity rate which they could not change later.

If you are one of the few who do not wish to commit to a lifetime annuity, then a fixed term annuity might be worth considering.

A fixed term annuity aims to provide the best of both worlds, a guaranteed annuity income and the flexibility of a drawdown later.

How it works

In a fixed term annuity, you will receive a guaranteed income for a fixed period which can be between three and twenty-five years. You can choose the amount of income that you wish to receive during this term.

At the end of the term period of the annuity, you will receive a lump sum of money called ‘Maturity Amount’, which can either be paid directly to you or can be invested in a second retirement income product depending on your financial situation then or your health status.

The Benefits 

One of the most important factors that differentiate a fixed term annuity from other types of annuities is that you do not have to commit to features like widows pension or death benefits at the outset for the rest of your lifetime.

Your personal or financial requirements can change at any time, and hence, any choices that you make will only be applicable for the term of the annuity.

At the end of the term, you can reassess your finances and then make an apt decision.

Here are some of the benefits of a fixed term annuity.

  • You can set the level of income you wish to receive from the plan (within government limits). If you opt for a higher income, then the maturity amount you receive at the end of the term will reduce.
  • If you consider that a drawdown is too risky but are not ready to lock-in your pension pot for life, then this is a great option to receive a fixed income for a specified number of years.
  • You have the flexibility to choose a single annuity, a joint annuity or a fixed income or an investment-linked income.
  • At the end of the term, the annuity rates may be higher which may allow you to receive a higher income.
  • Your health condition may not be the same after a decade. You may then qualify for an enhanced annuity which will give you a higher monthly income.
  • In the event of your death before the term is complete, a nominee (dependent spouse or civil partner) or your estate will continue to receive the full monthly income at the agreed rate and will also receive the maturity amount at the end of the term.

What’s the catch?

As is the case with all pension schemes, a fixed annuity plan may not be the right one for you in all circumstances.

  • To receive the full maturity amount, you must keep the plan for the entire term agreed at the outset. If you change your mind midway or have a sudden urgency for funds, and decide to cash in, then you may lose the funds.
  • The income will not change for the entire plan term. If your financial circumstances change, it may not be enough.
  • The annuity rates may fall by the time your plan term ends. If you chose to receive a higher income during the term, the maturity amount you receive would be lower. Subsequently, it may not be enough to buy the same retirement income in the years to come.
  • If your health deteriorates midway of the fixed term, you risk losing out on the maturity amount if you cash in. So, despite being eligible for an enhanced annuity, you will have to continue with the fixed term annuity.

Is it the right choice for me?

Retirees now have more flexibility in the way they use their pension pot. Speak to an FCA registered financial advisor to know what your options are and what will be the best choice for your retirement.

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

Fixed vs Increasing Life Annuity

One of the most difficult choices that retirees often face when looking to select an annuity is whether to opt for the instant riches offered by a fixed annuity or opt for an escalating annuity to safeguard the income from the inflation demon.

A common mistake is to be allured by the higher starting income provided by the fixed or level annuity without fully understanding how it will impact your lifestyle in the years to come.

As always, your choice of annuity is a very personal decision that depends on multiple factors like your health, your financial circumstances, your lifestyle, your lifestyle goals for the retirement years and healthcare costs.

But if you are standing at that crucial juncture twiddling your thumb, then let’s take a closer look and compare what each type of annuity has to offer.

Fixed Income Annuity

A fixed income or a level annuity will pay you a fixed income for the rest of your lifetime. It starts off with a higher yearly annuity payment as compared to other types of annuities. But the payments will taper down with time but not go below a minimum guaranteed payment.

Upside 

  • You will receive a higher amount to start with.
  • You will know beforehand what your retirement income will be, allowing to you plan ahead

Flipside 

  • Since you will receive the same amount year after year, inflation will erode its value with its sandpapered tongue.
  • You will be able to buy lesser with the same amount after a decade
  • The payment will be lesser during the later stages of the annuity

Is it the right choice for you?

If you have multiple pension pots and other funds tucked away that will cover you in the later stages of retirement; then you can take advantage of the higher income payout in the earlier years, offered by a fixed income annuity.

On the other hand, if you anticipate high healthcare costs in the later years, then you should consider other options.

Escalating or Increasing Annuity

An increasing or escalating annuity will provide you with an ‘inflation-proof’ retirement income.

There are two types of escalating annuities.

  • 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.

Upside

  • Your monthly income stays inflation-proof, and its buying power does not erode with time
  • Your income may increase in the later stages of retirement which may be beneficial if you anticipate healthcare costs.

Flipside

  • You may receive a much lower monthly income than what a fixed income annuity would provide you, especially if you choose a high annual rate of increment.
  • Some annuity providers set a cap on the maximum annual increase that you can get. Ensure that you read the fine print and know what you are purchasing.

Is it the right choice for you? 

If you have other income sources at this point in time, then you can opt for an increasing annuity. Despite having a lower income to start with, you will be well protected against inflation which can be beneficial in the later stages of retirement.

Most people underestimate the amount of time they may spend in retirement. On an average, you should expect to live at least 20 years in retirement. In the last decade, inflation has led to an average price increase of 3 to 4%.

Make the right choice

Ensure that you compare both options and then make an informed decision.

 

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.