How misunderstanding annuities can cost you thousands

Once the default retirement product for most retirees, annuities promise to pay a guaranteed income for life. In many ways this is excellent – what better scenario could there be than a guaranteed monthly income at a time in life when you are not working?

There are drawbacks, though. As with insurance policies, rates differ between providers, so not shopping around could cost you a significant sum over the years. In fact, research by the FCA found that of the people who purchase an annuity from their existing provider, 80% could have secured a better rate on the open market.

As annuities are typically irreversible and you no longer own your fund, you cannot correct a mistake. This means if you have a single-life annuity and die before receiving the value of your pension in income, the provider pockets the difference.

There are a number of different annuities to cover a range of situations, so it’s crucial to explore all of the options before committing.

Don’t lose 40% of your income

The basic principle of an annuity is that in exchange for a sum of money, a provider will pay you an income for life. The amount is based on a number of factors, including the size of your fund and how long you are expected to live.

If two people hand over the same amount of money but one is in perfect health and the other has a terminal illness, the healthy one will usually receive a smaller income. This is because they are expected to live longer, so their lump sum needs to stretch further. The person with the terminal illness could receive a higher income because the same amount of money will not need to last as long.

An enhanced annuity pays up to 40% more than a standard annuity to people with reduced life expectancies. Various factors could qualify a person for an enhanced annuity, including smoking, high blood pressure, obesity, diabetes and cancer.

Avoid the permanent lock-in

Once an annuity has been purchased it cannot be bought back. The government may make it possible to sell an annuity in the future – although it might not be worth what you think – but for now, you are stuck with it once you’ve bought it. 

That doesn’t mean you can’t avoid being locked-in, though.

One annuity option is fixed-term, which provides an income for a specified length of time. So instead of trading your pension for an income for life, you can purchase an annuity for five or ten years and then receive the remainder of your fund back.

This then allows you to either purchase another annuity or choose a different option using the new pension rules.

Protect your loved ones

With a standard annuity, the income you receive dies with you. If you would prefer to leave an income to a beneficiary, a joint life annuity may be a better option. These pay a percentage of your income – typically 33%, 50% or 100% - to a beneficiary, which can offer peace of mind that your family will be able to make ends meet. However, as the money is expected to need to last longer than for an individual, the level of income you receive could be lower.

An annuity may be the wrong choice

Annuities are not compulsory; there are a number of different options for taking a retirement income. The starting point for choosing one is first deciding what is most important to you – is it flexibility, security, passing unused money to beneficiaries, or something else?

The range of options can seem confusing, especially as the decision can affect the rest of your life and you can have a flexible plan that incorporates multiple products. Our quick and easy way to understand your retirement options highlights the main choices once you reach 55 years of age.

What are your priorities with your pension? Let us know with a comment below.

Call 0800 304 7288 for a friendly chat about your pension

The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article. For our latest information and news, please see our articles section:

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