Annuity Types

There are several options of annuities to pick from which are covered below.. There are huge differences between the income offered by the pension annuity rates of the various annuity providers - underlining the fact that you should always use the Open Market Option (OMO).

It is also important to remember that buying an annuity is one of the most important financial decisions of your life as it determines the amount of income you will receive during your retirement.

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Level annuity

Your income will stay the same each year irrespective of inflation. A level annuity, sometimes called a 'standard' annuity, pays the same income each year for the rest of your life. This has the potential drawback that the buying power of your income falls as prices rise through inflation. For example, when your annuity starts say the cost of your groceries are £50 a week. If inflation averages 3% a year for 10 years, their cost would rise to £67 per week. If you could still only afford £50 then you would have to buy fewer groceries. That is the effect of inflation.

Level annuities pay a higher starting income - compared to increasing annuities. Think carefully about the effect of inflation. Could you really cope with having no increases at all in your annuity income during your retirement, which could last 30-40 years?

Increasing annuity

This can either match inflation for the rest of your life or rise by a specific percentage each year.
To protect your income from rising prices, you can choose an annuity that is designed to increase each year. There are two main choices:

• Escalating Annuities - your income is guaranteed to increase at a fixed rate each year, commonly 3% or 5%.
• RPI-linked Annuities - your income is adjusted each year to reflect changes in the Retail Prices Index (RPI) - the main measure of inflation used by the government.

You do need to consider, however, with an increasing annuity the starting income is lower than you would get from a level annuity. For example, for a man retiring aged 65, the starting income from a 5% escalating annuity might be two-thirds or less of the income available from a level annuity.

To put it another way it could take more than 10 years for the escalating income to catch up and reach the same income amount as a level annuity or nearly 20 years before the total income you would have received from the escalating annuity exceeds the total from a level annuity.

Joint-life annuity

As the name suggests a joint life annuity gives your partner some or all of your continuing income if they outlive you.
The decision on whether you should choose a spouse's annuity will depend on you own circumstances but here are some of the points that should be considered....

• Does your spouse have an income of their own?
• If you died how much would your spouse's outgoings reduce by (less food to buy, less journeys taken, cheaper holidays, reduction in hobbies\activities). Remember not all outgoings reduce (fuel bills, home insurance, gifts)
• What debts would be left (mortgage, personal loans), would these be paid off?
• What is your age difference, would one of you be expected to outlive the other by a good margin? Statistically, women live 4 years longer than men.
• Choosing a spouses income results in a lower pay rate on the annuity, could you get by on the reduced amount?

Guaranteed Period

This will continue to pay out for a time to a nominated individual if you die soon after retiring.

Irrespective of the way you set up your payments they will be paid for your lifetime. However, you can also guarantee your annuity payments continue to be paid to your dependants, for up to ten years, if you die in the early years of your retirement.

Typically, as this is established at outset, this would be set at five or ten years. For example, if you were to secure a five year guarantee and die after two years of the annuity being in payment, the annuity will continue to be paid for the balance of the guarantee period, in this example three years and then cease.

Consideration of the guarantee period is important because it gives a known and secure level of income, allowing you easily to budget your spending against your income. This is especially so when taking into account the requirement of your dependant if you die first.

Enhanced and Impaired Life Annuities

If you have a medical condition or have regularly smoked you may get better rates

Enhanced annuities offer higher rates for individuals with medical conditions or lifestyles that shorten their life expectancy e.g. smokers. Impaired annuities offer higher rates for individuals with particular medical conditions, usually implying much higher mortality than applies to enhanced annuity purchasers.

After deciding on the type of annuity, there are subsequent options open to you which fall broadly into two categories:-

• Death Benefits
• Dependent Benefits

Investment-linked & With Profit annuity

Typically for those who have a larger pension fund, you may prefer your income still to retain a connection to the investment markets which can offer the chance of increasing your income over time. However, this does carry the risk that your annual income could go down as well as up. By selecting this type of annuity your annuity income is linked to investments with the chance if they perform well of a higher income in the future - but only by taking extra risk.

In this way Investment-linked annuities offer the chance of a higher income than you can get from level or increasing annuities (often called ‘conventional annuities'). By linking your income in retirement to an investment and in particular stock market or equity investment, means your income is directly affected by both the ups and downs of the performance of the investment over time.

It is important to remember Investment-linked annuities are more risky than conventional annuities because:

• your income is likely to change each year, so could go down as well as up.
• the size of any increase in unpredictable

If the risk of an unpredictable and possibly falling retirement income worries you then stick to conventional annuities.

Think Annuity would always recommend you seek advice before choosing this option.

With-profits annuities

This annuity is similar to index linked annuities, but these link your income directly to the performance of the insurance company's with-profits fund. Typically, your income is made up of two parts:

• a minimum starting income - this is usually set at a low level but, unless investment conditions are very bad, you will usually get at least this much income. Some with-profits annuities guarantee it;
• bonuses - The insurance company usually announces bonuses each year. Bonuses can be ‘reversionary' (usually announced once a year and guaranteed to pay out for the duration of your annuity) and 'special' - these only pay out a year or so until the next bonus announcement. The amount of any bonus depends on many factors, the most important of which is stockmarket or equity performance. Some insurance companies may guarantee a bonus rate, for example 3% a year. Sometimes you can choose the guaranteed rate, but the higher the guarantee, the lower your starting income.

Anticipated Bonus Rate (ABR)

Usually, your starting income is based on an ‘assumed (or anticipated) bonus rate' ABR. You choose the ABR at the outset from a range set by the insurance company - for example 0% (which assumes no bonuses at all) to 5%. Once chosen, most insurance companies do not allow you to change the ABR.

Your choice of ABR may depend on your need for income. For example, suppose you intend to carry on working for now. By choosing a low ABR you can plan for a low income now, increasing by the time you fully retire.
The insurance company announces new bonus rates every year. If the rate equals your chosen ABR then your income does not change. If the declared bonus is higher than the ABR, your income increases. But, if the bonus is lower than the ABR then your income falls.

If you choose a low ABR, your starting income is low. But, you increase the likelihood that future bonuses will exceed the ABR and that your income will rise. You also reduce the risk that your income will fall. If you choose a higher ABR, your starting income will be higher.

If you choose the lowest ABR of 0% - in other words, assuming no bonuses - your starting income will be the minimum. As long as the company declares a bonus, your income will increase. In general, your income cannot fall because the bonus rate can never be lower than 0%. However, if long term stockmarket performance was very poor, this may effect even this minimum starting income.

Think Annuity would always recommend you seek advice before choosing this option.

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