What is an annuity?

The new pension rules allow people to remove money from their pensions, but there is no obligation to use these new freedoms. Annuities remain on the market and will be an appropriate option for some people, but they can be confusing. With this post, we answer the question: What is an annuity?

As a basic definition, an annuity is an income for life, provided in exchange of your pension fund. You essentially sell your pension fund to an annuity provider, and in return they will pay you a specific amount of money for the rest of your life. This removes any worry that you may outlive your pension, and the income can be index linked to mitigate the risk of inflation eroding its value.

However, annuities are typically irreversible, so the decision to purchase one is not to be rushed into. The FCA has found that 60% of people simply stay with their existing pension provider when purchasing an annuity, yet 80% of those people could do better elsewhere – as a result, it has issued a new ruling that providers must include a competitor’s quote when offering their own to a client.

Aside from ensuring you get multiple quotes, it’s important to understand that there are different types of annuities and one may be more appropriate for you than others. We have previously explained the main types of annuities, but some of the available features are:

  • An index-linked income
  • An income for your spouse/a beneficiary after your death
  • A higher income if you have certain health conditions

 

Have the new pension rules affected annuities?

Prior to the pension freedoms, annuities were often seen as the default retirement product. Although they have not been truly compulsory since 2006, the government acknowledged in 2010 that “annuitisation by age 75 is effectively compulsory for almost all pension savers”, as a result of the tax charges of up to 82% on Alternatively Secured Pensions.

The announcement of the freedoms highlighted alternative products, which many people may have previously been unaware of. Popularity of annuities dropped, but they remain available.

There have also been some changes to annuities over the past year to bring them in line with income drawdown:

  • A joint life or fixed-term policy can be passed to the spouse, tax free, if the policy holder dies before the age of 75
  • If death occurs after 75 the income received by the recipient will be taxed as income at their marginal rate
  • Beneficiaries can be someone other than the spouse

There have also been discussions about the possibility of selling annuities. This is not yet possible, but the chancellor announced in the 2015 Budget that it would be allowed in the future. Annuity holders would then be able to sell their income in exchange for a lump sum, but this option would not be appropriate for everyone and the amount they receive may be lower than they expect.

What do you think of the changes made to annuities? Let us know with a comment below.

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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: https://www.portafina.co.uk/whats-new 

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