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How do you create an income in retirement? Many options exist, and one of them involves buying an annuity. In this guide, our team here at Hanson – financial planning in Liverpool – explains how annuities work, offering a summary of their pros and cons in 2021. We hope you find this content useful. Please speak with a financial planner if you’d like to discuss your own investments and tax strategy with someone.
What is an annuity?
It can help to draw a comparison between an annuity and an insurance policy. Life insurance, for instance, provides a lump sum to your loved ones if you keep up your premiums and you die within its terms. An annuity is also a type of financial product which you buy from an insurance company, except it pays out a regular income in retirement rather than a lump sum when you die. You also purchase it using funds from some – or all – of your pension pot(s).
Types of annuity
Annuities come in many forms. When choosing an annuity, therefore, it is important to make sure that it reflects your financial goals in retirement. Types of annuities include:
- Level annuities. This product pays out a flat income each year in retirement, for the rest of your life. It usually pays out a high rate at the beginning, but does not rise with the cost of living (inflation).
- Escalating annuities. A type of annuity which increases the annual payouts by a certain, specified amount (e.g. 3%). This product is typically costlier than the first type above, but will help protect your payments from inflation.
- Fixed-term annuities. This pays out a specific amount of money each year but these will stop at the end of the policy term (i.e. 5-10 years). When it ends, a lump sum is paid out. This can be a useful option if you want a guaranteed income for the time being but think that you could get a better annuity deal later.
- Guaranteed annuities. Here, your policy will continue paying out for a certain number of years even if you die within the term. If, for instance, you purchase a 10-year guaranteed annuity and die 2 years into the policy, then it will keep paying for the next 8 years.
- Value-protected annuities. A useful option if you want your loved ones to receive an inheritance, this lets your family receive part of your annuity back when you die. As an example, suppose you protected an entire annuity and bought it with a £200,000 pension pot. If you died after only receiving £60,000 of annuity income, then your family can receive a value protected capital return worth £140,000.
Which annuity is right for me?
If you are considering an annuity then it will be important to shortlist which types may be most suitable, depending on your financial goals. If you are likely to have dependents living with you for many years into retirement, then a guaranteed annuity could make sense – since they can continue receiving annuity income if you die before they are ready/able to move out. Whether or not you want your pension to form part of an inheritance, moreover, will influence the type of annuity you may end up choosing. A guaranteed annuity may be suitable, yet if you do not use all of your pension(s) to buy it then the remaining funds would go to your beneficiaries, free from inheritance tax (IHT).
Are annuities a good pension choice in 2021?
Annuities can be a great use of your pension funds but are not suitable for everyone. In 2021, products are generally offering lower rates than they did even just a few years ago. This is partly because the companies that offer annuities tend to generate profits from investing retirees’ money into low-risk bonds, where yields have been compressed due to historically-low interest rates. To remain viable, therefore, many of these companies have needed to pass these costs onto the customer. As such, some people may wish to retire using a “drawdown approach” for the time being (i.e. you keep your pension invested and gradually take an income from it). When rates hopefully improve in the future, you may be able to get a better annuity deal.
On the other hand, many people in/nearing retirement may not be comfortable with keeping their life savings in volatile investments like equities. The stable, guaranteed lifetime income from an annuity can be a reassuring alternative which offers more predictability and peace of mind. Others may wish to take a “blended” approach to their pension savings, perhaps buying an annuity where the income covers essential retirement costs (e.g. food and bills) whilst the “drawdown” part of their pension funds more discretionary spending – like annual holidays.
Conclusion & invitation
Are you interested in talking to a financial adviser about your pension and investment planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
You can call us on:
Liverpool Office: 0151 708 7616
Manchester Office: 0161 401 0991
Chester Office: 01244 960 039Or email via: [email protected]