Annuities: why laziness could cut your pension by 12%
New research has revealed that there can be sharp differences in annuity rates, even among the leading deals.
Getting the best possible income in retirement is getting tougher.
It's long been the case that the return you can get from different annuities can be pretty stark. But new analysis from Better Retirement Group has revealed that there are significant variances even among the annuities at the top of the best buy charts. It found the difference between the best rate and the fifth best rate on a £50,000 pension pot is currently an average of 12% for both level and enhanced annuities.
For example, a single male aged 65, who is a smoker and has a pension fund of £25,000, could get an enhanced annuity with fifth best Aviva for £1,542.36.
But with top place Just Retirement he could be £194 better off a year with an annuity paying £1,736.52. That’s nearly a 13% difference.
Rock bottom annuity rates
The insight from Better Retirement Group is especially important because annuity rates are at an all-time low. With retirement incomes plumbing new depths and the cost of living continuing to rise, shopping around for the best deal is vital.
According to Hargreaves Lansdown, a level annuity today would pay a 65-year-old male around 5.8%. On a £50,000 pot, that works out at £2,900 a year. Back in 2008 he would have been able to get a much better level annuity paying 7.8%, which is £3,900 on the same investment.
Why are rates so low?
The poor value of annuities is down to a number of factors:
Quantitive easing: insurance companies finance pensions by buying up gilts that are low risk investments. But because the Bank of England has focused its quantitive easing (QE) programme here, these are in short supply and so are more expensive.
The insurers pass this onto us in the form of lower annuity rates. Read Treasury Select Committee: pensioners deserve compensation! for more.
So far £325 billion has been spent in the QE programme and the next round is expected in July, which spells bad news for those about to buy an annuity.
Living longer: men and women are living longer than ever before. The average life expectancy for a UK-born male is 78 and for a female 82, according to the latest figures from the Office for National Statistics. So as life expectancy improves, annuity providers offer lower payments as they are required to spread the money over a longer period.
Cross subsidies: enhanced annuities offer better rates for pensioners with a shorter life expectancy than the average. But this is at the expense of the healthy, who prop up this deal in a cross subsidy. Improved underwriting means more applicants are being offered these better offers, so those in good health suffer with poorer deals.
Solvency II: new EU regulatory requirements will mean insurers may need to keep more cash in reserves, and likely a more conservative investment policy. This could result in lower yields on investments and therefore lower annuity rates for people about to retire.
Boosting your annuity
If your life expectancy is deemed to be below average you will be able to access an enhanced annuity which will provide you with a higher level of income in retirement than a level annuity can offer.
Factors such as your job, where you live, your health and your weight can all boost income on an enhanced annuity, so it is worth filling out the form to see if you qualify. For more information, check out Smoking could boost your annuity by 37%.
Alternatives to an annuity
If you are not eligible for an enhanced annuity, there are alternatives.
A drawdown plan means you leave your pension invested and withdraw an income every year. The advantage of this method is that if you die early in retirement, your family can benefit from what is leftover (after tax), which is not possible through an annuity.
However, the downsides are that you may withdraw too much and end up not having enough to live on. And if your pension remains invested there is a risk that the value could fall.
Another option is to split your pension fund, using some to purchase an annuity (giving you a guaranteed income for life) and using the rest in a drawdown scheme, thereby balancing the negatives and positives of each option.
You could also phase your annuity purchase, and buy your retirement income in a series of stages allowing you to (in theory) benefit when the rate eventually improves. This means going for a fixed-term annuity, which you can read about in Why thinking short-term can boost your pension!
Where to find the best rates
A great place to start is lovemoney.com’s annuity calculator, but you can also seek advice from an annuity broker such as Annuity Direct or Hargreaves Lansdown.
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