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Buying an Annuity the Right Way

After more than four decades of working, you have finally reached that point in your life when you have to make a decision about how you are going to use all the money you have put away in your pension. Despite pension reform giving us many more choices than we have had in the past, some pensioners are still choosing to purchase an annuity. That's great. Annuities are a wonderful way to ensure income for life without having to worry about budgeting.

The main concern with an annuity is that it is irrevocable. In other words, if you took your pension pot and invested in the stock market you could always change your mind and pull-out in the event the market does not perform up to your expectations. If you were to invest your money in buy-to-let property, you could always sell your portfolio if need be. Annuities are different. They last forever – even if you decide you don't want yours.

There is a right and wrong way to purchase an annuity upon reaching retirement. Do it correctly and you should have very few financial concerns during retirement. Do it incorrectly and you could regret your decision for years to come. We will outline the right way below. But please bear in mind that there is no such thing as a guaranteed investment. Buying an annuity the right way increases your chances of a comfortable retirement, but nothing is 100% foolproof.

Understanding Your Many Options

The first step in buying an annuity the right way is to understand your options. There are a number of different kinds of annuities to choose from. Each has advantages and disadvantages, so make sure you shop around and ask plenty of questions. You can purchase annuities from insurance companies, annuity brokers, and other specialist financial providers.

Your main choices among the many annuity types are as follows:

  • Lifetime Annuity – This is the most common form of annuity purchased in the UK. It offers you continual income regardless of how long you live after retirement, paying you a certain percentage annually for every pound you invest. Larger pension pots are capable of purchasing larger annuities.
  • Enhanced Annuity – This annuity is similar to a lifetime annuity except that it offers a slightly higher income due to shortened life expectancy. It is a good option for those with certain physical conditions that may limit lifespan.
  • Impaired Life Annuity – This is another annuity for people whose physical health suggests a lower life expectancy. However, because payouts tend to be quite a bit higher, insurance companies require medical documentation as proof that the qualifying medical condition exists.
  • Investment-Linked Annuity – The investment-linked annuity offers an opportunity to combine the security of a lifetime annuity with the extra earning potential of investing. With this product, some of the money from your pension is used to purchase basic income while the remainder is invested on your behalf. You will receive more as your investments earn.

There are other kinds of annuities we have not listed here but which might be made available through your insurance company or broker. They include things such as the purchased life annuity, temporary annuity, and postcode annuity.

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Step-By-Step Process

It is possible to purchase a deferred annuity with money you have today while delaying future payments until you actually retire. That discussion is better left for a different guide. For the purposes of this guide, we assume readers are rapidly approaching retirement age and beginning to think about their options.

Below is a step-by-step process you can employ to purchase an annuity the right way. Following this process keeps you on track so that you are not forced into making an ill-considered decision with just a month to go until retirement. These steps can obviously be adjusted according to your schedule should circumstances dictate for whatever reason.

Step #1 – Materials Are Sent to You

Somewhere around six months before retirement, your pension provider should send you an information package letting you know what your options will be. Some providers also offer annuities, expecting that you will just transition from a pension to an annuity with them. But please be aware you are not locked into buying an annuity from your provider. You can always take the money and go elsewhere.

The information package should clearly spell out all of your options – including any fees and charges associated with each one. Study this information carefully. If you have any questions, ask your pension operator or sit down and consult with a financial advisor.

Step #2 – Follow-Up with Your Provider

Within a 10- to 12-week window, your pension operator should send you a follow-up information package. If you don't receive it, do not sit around and wait for it to arrive. You don't have that kind of time. Inside ten weeks, you should contact your operator and ask for the follow-up information. The second package should include an annuity application should you decide to purchase from your pension provider.

Step #3 – Shop Around

Upon receipt of the follow-up package, you should begin shopping around for other annuities. There's no point in doing this any earlier as annuity rates change from month to month. Waiting until 10 or 12 weeks to go gives you enough time to do your research while still getting rate information that is likely to be accurate at the time of purchase.

Step #4 – Get Advice

Before doing anything with your pension pot, your operator is required by law to ask certain questions and, in the absence of independent advice from a financial advisor, do their best to make sure you are making the right decision. We advise working with an independent financial advisor or a volunteer advisor working for a financial charity. You want unbiased advice that does not necessarily lead toward buying an annuity from your pension operator.

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Step #5 – Make Your Decision

It will eventually be time to take all of the information and advice you received and make a decision. When that day comes, you will be trading in your pension pot for the promise of income for the remainder of your life. Be cautious with your decision, but do not put it off forever. Doing nothing out of fear could be more damaging than purchasing an annuity incorrectly.

Shopping around for Annuities

The last part of this guide explains how to correctly shop around for an annuity. Treat the shopping experience no differently than you would approach buying a car, a house, or anything else requiring a significant investment on your part. Buying an annuity has life-altering consequences that can be either good or bad.

You will get the best results from your shopping experience if you take a few minutes to really look at your current circumstances and future goals. Knowing what you want makes it easier to look for products that suit your goals while dismissing those that don't work for you. Your self-assessment should include an honest look at your health, your debt load, your daily living expenses, etc.

Next, do not dismiss what your pension operator offers without first looking into it. Buying an annuity from your operator may be the best thing you can do, but it may not be. Compare what they offer against nationally known annuities and a few lesser-known products.

Lastly, take advantage of comparison tables you can find online. Everyone from the news media to financial advisors to government websites publish comparison tables on a regular basis. These are excellent tools for finding the best rates at the time you buy. And as with any other financial investment, rates are everything.

Buying an annuity can be one of the best things you will do for your retirement. But make sure you do it right. Pay attention to the information your pension operator provides, get plenty of advice from experienced professionals and take the time to shop around and compare. Fully engaging in the process makes it highly likely you will be happy with your annuity decision over the long run.

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