How To Identify the Best Annuity For You
Members of defined contribution pension schemes have the option of purchasing an annuity when it comes time to retire. A pensioner can use his or her entire pension for the purchase, or use a portion for the annuity and the remainder in other ways. The most important thing to know is to shop around in order to find the best annuity for you. Annuities are complex financial products that offer a broad range of options.
Annuities used to be the default choice for retirement income prior to pension reform. Why? Because they guarantee income for life, regardless of how long the purchaser lives. However, falling rates and new freedoms offered by pension reform now make the annuity an option that is not necessarily right for every pension saver.
Identifying the best annuity for you requires getting all of the information and going through it with someone who understands how annuities work. You can work with a certified financial advisor or a charity such as Age UK. Doing so gives you access to expert advice that can certainly point you in the right direction.
How Annuities Work: The Basics
An annuity is, in its most basic form, a cash purchase product. In other words, you turn over the funds in your pension pot to an insurance company in exchange for a guaranteed amount of income for life. You are effectively purchasing future income by purchasing an annuity. You benefit from the acquisition by never having to worry about retirement income for the rest of your life.
As for the insurance company, they benefit in two ways. First, they take the money your pension provides upfront, and they invest it in their chosen investments in order to earn more from it. Second, they rarely offer consumers the full value of their pension pots as retirement income. This gives the insurance company an extra cushion in case you outlive the purchase price, or their investments do not make enough to cover how much they pay you.
The most common form of annuity for retirement purposes is known as the lifetime annuity. You can purchase it as a single annuity for yourself, or as a joint annuity that guarantees your spouse receives some benefits upon your death. The Citizens Advice Bureau recommends you ask yourself three questions before choosing a lifetime annuity:
- Do you want income only for yourself or for you and a partner?
- How do you want to receive the income derived from the annuity?
- What is your current health and how long do you expect to live?
These three questions will determine the best way to establish an annuity should you choose to buy one. Bear in mind that you may not be eligible for a joint lifetime annuity if the age difference between you and your partner is more than ten years.
Many Kinds of Annuities
We mentioned earlier that annuities could be complicated. What makes them complex is the fact that there are so many options for purchase. We have listed those options below, but we have provided only an overview. It is crucial that you get qualified advice in order to have a full understanding of what your options are. In brief, you can choose from among the following:
- Level Annuity – This kind of annuity pays you a level amount of income for life, regardless of how long you live.
- Increasing Annuity – An increasing annuity pays you a larger sum each year to make up for inflation. It requires you to start with a lower base payment in your first year.
- Enhanced Annuity – Pensioners with certain qualifying medical conditions can purchase an enhanced annuity. It is a product that pays higher levels of income to high-risk individuals not expected to live for too long after retirement.
- Investment-Linked Annuities – An investment-linked annuity guarantees you will receive income for life, but how much you will receive will depend on investment performance. Your money remains invested in the stock market for the life of the annuity.
- Capital Protected Annuity – This kind of annuity is one that guarantees a total amount of income regardless of how long you live. Should you die prior to reaching this amount, the balance is paid to your survivors.
As you can see, simply settling on a lifetime annuity is not all there is to the decision. The annuity provider will present you with these other options before asking you to make a choice. This is where shopping around comes in handy. Not only do you need to know the specific kind of annuity that is right for you, but you also need to find the insurance company offering the best deal on that annuity.
Determining What's Best for You
With all the information in hand, you will eventually have to make a decision about the kind of annuity that is best for you. Taking it one step further, you may decide that purchasing an annuity is not the right choice after having weighed up your options. This is why the advice of a financial advisor is so valuable. Together, you and your advisor will want to work out what your retirement goals are and how best to achieve them.
For example, are you content just providing your own income during retirement or do you have a desire or obligation to provide for others as well? If you only need to provide for yourself, you may be better off with a simple level lifetime annuity. Providing for a partner and/or children may mean purchasing a joint lifetime annuity or a capital-protected annuity.
Next, are you interested in continuing to grow your money during retirement? The answer to this question may open the door to investment-linked annuities or purchasing a lifetime annuity with part of your pension pot while steering the remaining money into other investments.
Third, can an annuity sustain you within the kind of lifestyle you expect to enjoy during retirement? If so, the peace of mind that comes with lifetime income may make purchasing an annuity your best bet. If not, you may need to think about one of your other options instead. You may have to invest elsewhere in order to achieve enough income to sustain your lifestyle.
Your Other Options
Should you decide that the best annuity option out there is still not right for your circumstances, you do have other choices. You can use your pension pot like a bank account, slowly drawing from it as needed while you supplement with your state pension. Another option is to enter a drawdown contract that stipulates you will receive a certain amount every year. This is another good option for those who want to combine both personal and state pension payments to provide total retirement income.
A third option is to direct your pension monies into other investments that provide growth through capital gains. For example, you might invest in a number of different mutual funds along with some stocks and shares. You may even purchase government securities or corporate bonds to provide some balance and stability.
In the end, it comes down to doing a lot of research, getting a healthy dose of qualified advice, and shopping around. We recommend you do the following if you are approaching retirement age within the next five years:
- Contact a few banks and insurance companies for information about their annuity products. Start learning now how annuities work.
- Spend some time with your financial advisor to review your current retirement plan. Make any modifications you need to bring your plan in line with your retirement goals.
- Should you decide an annuity is your best option, begin shopping around with about six months to go before retirement. Any earlier than that is not appropriate because annuity rates can change so frequently.
Whether you choose the best annuity or another retirement option, choose wisely. If you do elect to purchase an annuity, remember this: once you purchase there will be no going back.
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