Annuity rates are at an all-time low. From a heady 15% range in the early 90’s to the current gutter level of less than 6%, annuity rates have fallen and look likely to remain at or around this level for many years to come.
However, certain specific personal circumstances could improve these rates. For instance a smoker would be entitled to a better rate than standard as would someone on high blood pressure and cholesterol tablets, in fact any health problem that could reduce your life expectancy.
Also, just getting older will entitle you to a better rate since the period that the benefit will be paid for is shorter.
This latter reason for receiving a better rate is tempered by the phenomenon of ‘Morbidity Risk’. This takes a bit of getting your head around but annuity companies operate a discount if you buy an annuity later than normal (age 65 for men for instance).
If everyone buys an annuity at age 65 (as used to be the case) then the company knows that some will live for a long time and some will die very early. So they can work out the probable average and calculate the rate accordingly. However, if you don’t buy your annuity until you are aged 70 then you won’t be able to benefit from the subsidy that those dying early will have provided. Hence the discounted annuity rate.
What do the calculations look like? – Well, let’s take a male aged 65 (we’ll call him Tom) who has a pension fund of £100,000 after taking the tax free cash. Tom could expect to receive an annual income of £5,700* based on a level pay-out for a single life with a 5 year guarantee.
If Tom delayed buying an annuity for 2 years he would receive £6,000* per annum using the same basis and assuming annuity rates remained identical.
So, deferring the annuity 2 years will increase the annual income by £300 but the amount lost and therefore to be made up over the years would be £11,400. (£5,700 x 2).
It would be 38 years before the same amount would be received in total and Tom would be aged 105!
Let’s assume that during the 2 years of deferral Tom’s pension pot increased by 10% to £110,000 and annuity rates fell by 5%. In this case the annual annuity income becomes £6,270* and it would take Tom 18 years to recoup the lost 2 years income; taking him to age 85 to break even.
This position would be even better if Tom were to be diagnosed with a health problem that could reduce his life expectancy.
So what sort of questions should you be asking yourself prior to making a final decision? – The following is a starter list but is not exhaustive.
1. Are annuity rates likely to rise or fall?
2. Is my pension pot likely to increase or fall in value?
3. Am I likely to contract a health problem that will potentially shorten my life?
4. Is my spouse likely to die before me or before I need to make a final decision?
5. What happens to the pot of money if I die?
6. When am I going to die?
OK this last question is a bit facetious but it has a serious reason behind it, linked to question 5, in that if you don’t buy an annuity and leave the pension uncrystallised then on your death your beneficiaries would receive the pension pot as a lump sum without any tax charge. However, if you do buy an annuity and die prematurely then the pension will be lost unless you have included a spouse’s pension option.
Another option is that you might like to take some money now to tide you over and this can be taken either as a lump sum that is currently tax free or as a mixture of lump sum and annuity payments by only crystallising some of the pension pot. This would mean you would get some income now and any uncrystallised pension would go to your spouse on your death in full.
On the other hand you might prefer to simply take the tax free cash as and when you require it and use it to fund your income requirements for a few years then create an income from the residue after the tax free cash has been used.
There are so many options that it is virtually impossible for the lay person to decide on his or her own. There needs to be a qualified person who can discuss your situation and objectives with you to help you to come to a sensible and considered decision.
Yes you will need to pay that person for their time and knowledge but I can promise that their advice will cost much less than the cost of making a mistake that could be irreversible.
*Figures from Money Advice Service comparative annuity tables 08/08/12. Based on male, age specified, £100,000 fund, single life, five year guarantee.