To understand “annuities”, you first need to know that broadly speaking, there are two types of workplace pension.
The first is a “defined benefit” (or “final salary”) pension, which gives you an annual income from your employer once you retire.
The amount you get is usually based on factors such as how long you worked for the company, and how much you earned.
The second type is called a “defined contribution” pension. Under this approach, you and your employer both put money aside into a pension pot, during your employment.
This money is usually invested, therefore allowing the pot to grow through compound interest as you continue to contribute to it. From the age of 55, you then have a range of options as to what you do with this pension pot when you decide to retire.
One of these options is to buy an annuity. This is a kind of financial product which guarantees you a guaranteed annual income during retirement. It will do this either for a set period, or for the rest of your life depending on the terms of the product you eventually choose.
As such, most people who consider buying an annuity are people who contributed to one or more defined contribution pensions throughout their life.
Types of Annuities
Annuities come in different shapes and forms. So if you, a friend or loved on is considering buying one, then it’s important to know some of the differences between them.
First of all, there are Lifetime Annuities. These products pay you a retirement income for the rest of your life. They might also pay to a beneficiary you nominate after you die, although this is an option offered not by all products.
Secondly, there are Fixed Term Annuities. Rather than pay you an income for life, these pay out an income for a defined period of time. For instance, 5 years or 10 years are common terms.
Thirdly, there are Single-Life Annuities. This is where you get an income from the insurance company until your death. Unless you opt for a “guarantee period”, this is where the payments would stop. This can be a good option, for instance, for people with no dependants or children.
Fourthly, there are Joint-Life Annuities. Under these products, a portion of your income is paid to a designated person after you die. For instance, you might choose this if you have a spouse with no pension(s) of their own, to give them a retirement income in case you die before them.
The distinctions don’t stop there. Other types of annuity include:
● Enhanced Annuities. Also known sometimes as Impaired Annuities, these will pay you a higher retirement income if your lifespan shortens.
● Inflation-Linked Annuities. These annuities will pay you an income each year, which rises in line with inflation. This helps ensure that the purchasing power of your retirement income remains stable over the years, rather than eroding due to rises in inflation.
● Level Annuities. Unlike Inflation-Linked Annuities, these annuities pay out the same income to you each year. Although these often give you a higher income when you start out, it does leave your income vulnerable to rises in inflation.
Where Can I Buy An Annuity?
You are not restricted to only buying an annuity from your pension provider, although you should check what they are prepared to offer you.
From there, you can shop around. Most places selling annuities are insurance companies. You can then compare what these companies offer you compared with your own provider.
If they offer you a higher rate, then you might want to consider taking your pension fund to them. In some cases, shopping around can result in a much higher retirement income – sometimes as much as 30% higher. So it’s worth taking the time to explore your options.
Should I Buy An Annuity?
Buying an annuity can sound like the best option. Many people are particularly attracted to the idea of a guaranteed lifetime income, which can be very comforting.
However, buying an annuity is not your only option when it comes to securing a retirement income. There is income drawdown as well, for instance, which in some cases can give you a higher retirement income than buying an annuity.
Of course, whether or not you should buy an annuity completely depends on you financial goals, needs and circumstances. For instance, you need to consider what your desired income is, as well as what expenses you anticipate in retirement. This alone will affect whether an annuity is suitable for you.
Remember, what’s right for your friend or family member (who bought an annuity) might not be right for you. Speak with an experienced, qualified independent financial adviser prior to making any big decisions – as this will help you gain a better grasp of your options.