You really must shop around to get the best annuity rates when you approach your retirement. For those thousands of Scots retiring in the coming weeks and months, how they use their pension fund will be one of the biggest financial decisions ever made, and many will use their hard-earned money to buy a pension annuity, but now, probably more than ever, this decision requires very careful consideration.
Several different factors, including volatile stockmarkets and plummeting pension annuity rates, have combined to make the purchase of a pension annuity, which provides a guaranteed income in retirement, less straightforward than ever for pensioners. There remains a huge difference in the market between the best and worst annuity rates, with millions of people losing out by sticking with pension providers that don’t offer them a decent rate.
With many people now retired for around 20 years or more, there’s a lot of time in which to have to count the cost of taking the wrong option at retirement, but those nearing retirement now can take a few simple steps to get the best out of buying an annuity. They can shop around, but, according to the most recent figures published by the Association of British Insurers (ABI), 63% of retirees last year bought a pension annuity from their existing pension provider without looking for better rates. Those investors with the more competitive annuity providers – including Aegon, and Aviva (was Norwich Union) – are often better off staying put, but others are paying the price either for their (misplaced) loyalty or their complete apathy.
It’s actually estimated that someone sticking with an insurer offering some of the least competitive annuity rates could be getting about 30% less income from their annuity than if they used the Open Market Option (OMO) to shop around for the best rates. But, apparently four in five retirees have never heard of this OMO, according to leading annuity provider Just Retirement. The pensions industry is simply not doing enough to highlight the OMO to pension savers when providing details of available retirement benefits. While it (the OMO) is always included, it is clearly not being given enough prominence, often being hidden away on the last of many pages of documentation.
In addition to shopping around, there is always the enhanced annuity or impaired life annuity to consider, especially in Scotland which has a poor health record. These are available to both smokers and those with medical conditions that could reduce their life expectancies and they do pay out a higher annuity income on the assumption of a shorter payout period. Taking an enhanced annuity could result in an income of up to 50% higher than might be paid by the current pension provider, which will tend not take account of your health.
Unfortunately, people are conditioned to downplay things and not to reveal things, but this is the one time to tell your insurance company if you smoke, or if you have one of the 1,500 medical conditions that might entitle you to enhanced annuity rates, such as high cholesterol, high blood pressure, being overweight, or diabetes.
Recent years have seen some investors take a much more sophisticated approach to buying their annuities. With pension annuity rates on the slide for the past year or so and pension fund values hit hard by stockmarket turbulence, many retirees have sought to do some phasing of their annuity purchase in the hope that rates will improve over time and their funds will recover. For example, someone buying a pension annuity with a £100,000 pension pot might break it down into three segments. They may use a third of it to buy a level annuity so that they can get the maximum income from it from day one; another third could be used to buy a 100% spouses pension; and the final third could be used to buy a retail prices index (RPI) linked annuity, to hedge against inflation.
You could opt for a fixed escalating annuity, where the income paid out increases by a certain fixed amount each year, usually 3% or 5%, and this can provide a useful halfway house between a level and RPI-linked annuity, and these escalating annuities are pretty good value for money. RPI-linked annuities provide total protection against ongonig inflation but they are expensive and provide a far lower starting income thatn an annuity with a fixed percentage increase built in.
