The only real guarantee – and it’s not what you might think

We all want certainty in life. But life tends not to do that – it’s bad at guarantees. So, you may be surprised to hear there is one guarantee that comes at a time in life when you’re near peak uncertainty. Welcome to the humble annuity.

What are the most stressful decisions you’ve had to take?

A house purchase? Starting or ending a relationship? Making that great person redundant? Worse?

Try working hard all your life, building your retirement pot, and then using all that treasure to buy an insurance contract … in a decision you’re not allowed to reverse.

That’s what some 72,000 people do every year when they buy an annuity – a financial product that guarantees you an income for life.

These days that income could be paying you between 6% and 9% ... and perhaps higher.

Guaranteed income

Yes, you read that right, it guarantees you an income from the moment you buy it until you die, and perhaps even beyond that.

In my line of work we often talk about how an investment product might do this, or it could do that, or perhaps it may behave in such-and-such a way.

Annuities are different. They will give you an income for life. And this addresses the risk you might run out of money.

That’s because the insurance companies who sell annuities measure up your pot, they look at interest rates, they estimate how long you might live, and they package it all up into an income for you.

And because you’ve saved hard and done the right thing they essentially say, ”it’s yours until you die – perhaps longer. If you live more than we guessed then you’ve done well. If you live less, well, we’ve done our best to give you a good deal.”

Not so long ago, annuity rates were pure parsimony. They’re linked to interest rates. When the Bank of England chopped rates back to almost zero in 2009, annuities were very poor value. But now, with the base rate back up to 5.25% (at the time of writing), annuities are excellent value again.

Plenty of choice, plenty of options

You probably know financial products come in all shapes and sizes. Annuities are no different.

Level annuity. Enhanced annuity. Joint lifetime annuity. Deferred annuity. Variable annuity. The list goes on. The (very good) annuity platform Assureweb offers 200 products from 35 providers. What do they all mean?

Firstly, they all solve the same problem: how do you guarantee a secure income in retirement, irrespective of how investment markets are doing?

  • A level annuity will pay you a fixed, guaranteed income of money for the rest of your life. These tend to pay out around 6%.
  • Enhanced annuities are the ones paying 8 or 9%. The income is higher because they’re for people with health conditions who may not live as long.
  • An escalating annuity pays an income rising by a fixed percentage. Your income at the start of the will be lower than had you purchased a level annuity, but will increase over time.
  • An index-linked annuity pays an income that rises in line with inflation. Again, early payments are lower, later ones higher.

Secondly, whichever option you choose, you almost always have the choice of additional benefits.

  • Worried about the pension money ‘dying with you’? Buying value protection can protect all or part of the amount used to buy your annuity.
  • Concerned about the financial position of your family? An annuity guarantee period enables you to divert payments to a loved one after your death.

An important thing to remember is, if you live long enough, there’ll be a point where you get your money back and all future income will be “free”.

When is an annuity not a pension annuity?

Don’t worry, this isn’t the worst joke you’ll hear today. And, having Googled “annuity jokes”, I don’t think any actually exist!

In any case, I’ve been talking about pension annuities so far. But you can also buy an annuity – namely a future income stream – with a pot of money that isn’t a pension. These are called purchased life annuities. In simple terms they’re the same thing: you use a pot of money to buy a product that pays you a guaranteed income.

Back in the day retirees had to buy an annuity by law. But that all changed about ten years ago.

So, today, you have lots of options with your pension. You can take 25% of your pension pot tax-free, you can withdraw money from it (known as pension drawdown) or buy a guaranteed income (the annuity).

Most of our clients do some or all the above, mindful of their wealth outside the pension, mindful of their lifestyle expectations, and mindful of their tax position. There’s a lot to think about.

Difficult decisions

I mentioned before there’s a lot of choice in annuity-land. Some 200 products from 35 companies means it’s essential to shop around. Selecting one product over another can mean the difference between 10 or 12 nice meals out per year.

I also mentioned the stress of having to use the pension pot you’ve built up over your working life in a single transaction that locks you in for life. You can’t return your annuity. You can’t ask for your money back within 28 days.

But retirement almost always means big decisions. And that’s where experts like us come in, to help you choose, so you can benefit from the value offered by a guaranteed income, and perhaps instead focus on the fun things you’ve worked so hard for.

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