Lockhart Grey Financial Planning Ltd

Annuities are used to provide a retirement income, in the case of pensions this income is guaranteed for life.

The pension lump sum is exchanged for a regular pension income. Once the annuity has been bought, the income is fixed and the contract cannot be reversed – the pension lump sum  paid becomes the permanent property of the annuity provider.

The level of income that you will receive from an annuity depends on a number of factors including but not exclusively:

•    The value of the pension fund at retirement
•    Age of ‘annuitant’ (or member)
•    Your Health
•    Your Sex
•    The prevailing annuity rates at the point of the annuity purchase

In general, with all things being equal, the older an annuitant the higher the income that can be secured. Furthermore males usually receive a higher income amount than females due to generally having a shorter life expectancy.

How they work…
Annuities, as a general rule, are supplied by Life Assurance Companies. The underlying ‘annuity fund’ is usually invested in a number of fixed interest investments, such as long term government gilts.  This is to maintain the guaranteed income and ensure regular income payments are made to annuitants.

Annuities can be set up to provide a number of different benefits / options:-

•    Spouses pension (this is to protect a spouse, by providing an income, following the death of the annuitant)
•    Guaranteed pension payment periods; 5 years is typical but 10 year guarantees are also possible
•    Escalation of benefits; income can be protected from the eroding effects of inflation – RPI linked escalation, alternatively a fixed % annual increase in income can be secured at outset eg 5%.
•    Annuity income may be linked to the investment performance for example by a ‘With Profit Annuity’ or ‘Unit Linked Annuity’

Annuity Options…

With Profit Annuities

Annuities: The main options available:-

Level Annuity

Income does not increase in payment. It provides the annuitant with the highest attainable income from the outset compared to other options. However, as time goes by and inflation sets in, the value of the pension, in real terms will decrease. In the case of someone who retires early and then lives a long time, this reduction in ‘buying power’ could be quite considerable.

Joint-Life Basis

With this option, either a full or reduced income will continue to be paid to the surviving partner if the annuitant dies. As women tend to live longer than men, a wife several years younger than her husband could reduce the income payment offered at outset quite significantly. Joint life annuities are mainly taken out by married couples, especially if the spouse has no other independent pension income.

Guaranteed Annuity

It is possible to ensure that the income that is to be paid is guaranteed at a set level for a period of time after the death of the annuitant. Typical guarantee periods may be 5 or 10 years. For instance if the annuitant dies three years into a five year guarantee period, the provider will pay the deceased annuitants beneficiary for an additional two years. By taking this option the starting income will almost certainly reduce.

If the annuity is taken out on a joint-life basis and both parties die within any guarantee period, the payments will continue to be paid to the deceased annuitants estate.

Escalating Annuity

An escalating annuity will provide an income that will increase annually at a predetermined rate, or sometimes in line with the retail price index. The advantage of this is the income may provide some protection against the effects of inflation. However, the initial starting income will most likely be reduced in comparison to a level annuity.

With or without overlap
This is applicable when a joint life guaranteed pension has been chosen. With overlap, the spouse/dependant’s pension will start immediately upon the annuitant’s death. Without overlap, the pension will start at the end of the guaranteed period or immediately upon the annuitant’s death, whichever occurs latest.

With profits & unitised Annuities

Traditional annuities will provide a guaranteed income; however, there are other types of annuities now available, namely with profits & unitised annuities. They differ from traditional types in that the guaranteed element is either reduced or completely taken away altogether in exchange for the possibility of increased income over the long term.

In respect to a with-profits annuity, a low guaranteed income level will be initially secured and then an annual bonus may be payable from the (linked) with-profits fund. The level of income therefore fluctuates from year to year and will be dependent upon the success or otherwise of the With Profits fund.
Under a unit linked annuity, no guarantees will be provided. The income that is received is dependent upon the underlying performance of the linked fund/s, which will undoubtedly fluctuate over time. With favourable market conditions, a unit linked annuity may, over the long term, produce an income that may exceed that of a traditional level or escalating annuity. The problem is that the reverse is also true; if there are adverse market conditions this may seriously affect the value of a pension income.

Phased Retirement

Phased retirement, (which is also known as ‘staggered vesting’), allows the purchase of a pension to be phased, thereby allowing more flexibility when considering retirement

Phased Retirement plans achieve this flexibility by periodically encashing any number of segments of the plan to produce pension income. These plans are usually split into a large number of  individual segments, perhaps a 1,000 or more, to assist the process.

Each year the level of required pension income is determined, which subsequently determines the number of segments that must be encashed to meet the income need. The annual pension income is made up of a combination of tax free cash and annuity from the individual segments. The remainder of the fund will remain invested and may benefit from any market growth in its underlying investments.

These plans are available up to the plan holders 75th birthday, at which point the remaining segments have to be converted into either pension annuity income or transferred to an Alternatively Secured Pension plan.
Phased retirement plans will tend to carry a higher management charge and due to their nature are usually only considered suitable for clients that have pension assets in excess of £100,000. Another drawback of these types of plan is that the Pension Commencement lump sum ( tax free cash) is not available on the vesting the pension benefits into the Phased plan. The tax free part of the encashed segments will form part of the annual pension income. (Any remaining tax free lump sum will not be available until the final vesting of the remaining segments).

Phased Retirement plans can, it seems, be relatively complex and are not suitable for everyone, but they can, for some individuals, offer a flexible approach to retirement. Careful consideration must be given to an individuals own personal circumstances, including the value of their existing pension/s. We strongly recommend you seek advice from us if you are considering this option.