There are a variety of options available to you with your pension annuity, the income in retirement you buy with your pension fund:
A single-level annuity is the simplest type of pension annuity. It pays out exactly the same amount to an individual (the “annuitant”) every month until the annuitant dies.

A guaranteed annuity pays out an annuity payment each month for at least the length of the guarantee period, even if the annuitant dies before the end of the guarantee period; in which case the guaranteed annuity payments are made into the annuitant’s estate. The maximum guarantee is ten years. Five years is quite common in practice.

With an inflation-linked annuity the annual payments increase by the rate of increase in the Retail Prices Index (RPI) to give payments protection against inflation.

With an escalating annuity the annual payments increase by say 3 or 5 per cent to give the pensioner some protection against inflation and to allow for possible increased income needs as the annuitant ages.

Joint-life or last-survivor annuities pay an agreed annuity payment to an annuitant and the annuitant’s partner while both are alive. Following the death of the annuitant the contract pays either the same amount or an agreed reduced amount each month until the partner dies. The reduction in last-survivor annuities is typically a half to one third.

Investment-linked annuities involve the fund backing the pension annuity being invested in an equity product. The annuitant receives an annuity payment that is related to the performance of the equity market.

An impaired-life annuity pays an increased annuity payment if the annuitant has health problems, such as cancer, chronic asthma, diabetes, heart attack, high blood pressure, kidney failure, multiple sclerosis or stroke.

An enhanced annuity pays a higher annuity payment related to actuarial considerations.

Phased-retirement or staggered-vesting annuities. With these, instead of converting the whole pension fund, withdrawals are scheduled over several years. This is achieved by splitting the fund into many separate segments.

A with-profits annuity links income directly to the performance of the insurance company’s with profits fund. Typically, income is made up of two parts: a minimum starting income and bonuses.

A short-term annuity allows an individual before 75 to use part of a pension fund to buy a fixed-term annuity lasting up to five years. They can choose annuity options in much the same way as basic annuities.

Value-protected annuities pay a lump sum on the death of the annuitant, equivalent to the difference between the original purchase price and total payments made. The lump sum is taxed at 35 per cent. They are only available until aged 75.

With so many choices it is wise to seek out specialist advice when buying your pension annuity.

That’s right, live in the wrong place with the wrong postcode, and your pension annuity could be less. Your postcode can affect your pocket in some less obvious ways. Companies are increasingly using precisely where you live in the country to pigeonhole you and your lifestyle, using the information to determine how much you will pay for everything from your house insurance to your pension annuity.

They claim this makes the assessment of risk more accurate, and premiums cheaper for everyone, but if you don’t fit the profile or you fall on the boundary you could end up losing out, and quite heavily. This can be seen quite clearly with car insurance and proximity to city centres. 

The theory is that the more affluent you and your neighbourhood are, the longer you live. Glaswegians have an average life expectancy in their early sixties, while people living in Surrey will on average live well into their eighties. The rub is, whilst that is good for the individual living longer with the pension annuity, the more expensive your pension annuity is for the insurance company paying your income in retirement, as it will be paying out for longer. And in recent years, some insurance companies have started taking account of customers’ postcodes when deciding what annuity rate to pay them.

Prudential, a major player in the pension annuity market, argues that the assessment is based on your full postcode, which refers to an average of 14 houses on a street or within a few square miles, but the data about the health and wellbeing of those residents is based only on its existing client base, not the population as a whole.

“Using your postcode to help determine how much you get in retirement seems to be a creeping policy,” says Tony Attubato, from The Pensions Advisory Service. “This is understandable when you consider that Glaswegians typically live to their late sixties whereas those on the south coast often live into their early 80s. But surely a customer’s individual lifestyle and medical situation should determine that risk without taking into account the irrelevant health of those living around them? The difference between annuity rates is significant and those approaching retirement really must shop around for the best rate for their pension pot.”

Therein lies the message. Yes, your postcode can now have an effect on the pension annuity rate you are offered, but there are other important factors which could entitle you to a higher annuity rate; you might smoke, or you might have a condition entitling you to an enhanced annuity or an impaired life annuity. So, shop around.

The open market option is applicable to retirees with a pension fund to be used to buy a pension annuity. It allows them to shop around for the best annuity rates from all annuity providers in the market. This is best done via a ‘middle man’, an independent financial adviser (IFA).

Results of the Financial Services Authority’s (FSA) thematic work on open market options is a step in the right direction, but the message must be stronger if consumers are to benefit from the highest level of retirement income, their pension annuity income, when they come to retire.

Literature from life companies is unclear regarding the open market option. Consumers should be in no doubt that they have a choice of pension annuity providers and therefore a choice of annuity rates and how much they could increase their retirement income. One option is to force life companies to include open market pension annuity rates on the quote allowing clients to compare differences in income.

The open market opition should be up front and in bold. Some documentation is so unclear it probably doesn’t meet the FSA’s Treating Customers Fairly (TCF) initiative. Factors such as health or even where the client lives (postcode rated pension annuities) must be considered. Impaired life annuities or enhanced annuities can significantly increase income. There are other things to consider such as death guarantees, inflation increases and widows pensions.

Only by taking independent financial advice will a person on the point of retirement be sure they are making the right decision and receiving the best available income. So make sure you take proper advice when purchasing your pension annuity.

An independent financial adviser (IFA) has launched an attack on Abbey Life for automatically vesting his client into its own pension annuity without the client’s consent. The IFA states that the client has major health problems and approached him after receiving literature urging him to take out a pension annuity with the closed-book provider (not offering or taking in new business) before retirement. While waiting for Abbey Life to accept his client’s letter of authority, the IFA says it became apparent it had vested the plan already but not paid out as the client had not signed any paperwork. The plan was vested on the worst possible terms (allegedly), with no tax-free cash, no widow’s option and the pension annuity income paid annually in arrears.

The IFA states that it is surely about time the Financial Services Authority (FSA) made the open market option for pension annuities the default option at retirement. This client was so confused with all the bits of paper. He was eligible for an enhanced annuity and would have got a far bigger payout elsewhere with much improved annuity rates.

Naturally Abbey Life wanted to defend their position, as Neil Tointon states: ”Many policy terms and conditions make it clear that the policy will be converted to an annuity at normal retirement date if we do not hear from the policyholder to the contrary.”

He would say that, wouldn’t he. The point is, though, that this client has lost out heavily in his pension annuity retirement income because the industry we are in has allowed this to happen, and this does need to change and soon. 

An interesting statistic: only 13% of people over age 50 who have consulted a professional for financial advice purposes discussed pension annuities, equating to just over half a million people. However, research from LV=, a leading player in the pension annuity market, shows that access to specialist financial advice can have huge benefits when it comes to purchasing a pension annuity.

In 2006 413,013 consumers purchased a conventional annuity. Some 40% of consumers buying a pension annuity could qualify for some form of enhancement, meaning over 165,000 people could have benefited from an enhanced annuity. The number of people who bought an enhanced annuity in 2006 was 22,686. Therefore, over 142,500 people could be missing out on additional retirement income because they have not purchased an enhanced annuity even though they may have qualified for one.

It is estimated that over £53m of pension annuity income each year is being missed out on by consumers who have not purchased an enhanced annuity (figures based on the amount of people who purchased pension annuities in 2006, sources: ABI, Watson Wyatt, FSA, LV= calculations). This is clearly a huge amount of extra income which would go a long way to assisting people’s retirement wealth.

People’s awareness of their right to purchase their pension annuity via the open market option is increasing, and tools such as the FSA’s Money Made Clear initiative is clearly contributing to this. However, it seems as though consumers are still not sure how to use their open market option, and they would like to shop around, but are not sure how to go about it.

For people facing retirement, help and advice on how to maximise their wealth and income in retirement is key, especially in the current climate. The industry needs to work with this audience and direct them to professional independent financial advice sources to help them achieve what is readily available.