The Association of British Insurers (ABI) is shining a light on the poor value millions of retirees are getting when they hand over their pension money to insurers. For the first time ever, it is publicly exposing the alarming 31 per cent disparity between the best and the worst conventional annuities on the market.
According to the ABI's new "Annuity Window" tool, in July 2013 Reliance Mutual was offering the best rate, while Scottish Widows was offering the lowest. On an example amount of £18,000, this means the difference between receiving £1,100 a year and £840 a year for the rest of your life. Over a 25 year retirement that would be an extra £6,500 income paid out by the best provider.
Experts have welcomed the tool, which makes stingy rates offered by insurers public for the first time, and hammers home the importance of shopping around for the best deal on the open market, instead of just saying 'yes' to what’s offered on a plate by your pension provider.
The move is likely to ramp up the pressure on annuity providers to offer better annuity rates, which would be excellent news for retirees.
However, retirees need to remember that annuities aren't the only option you may wish to consider if you don’t mind a bit more risk, particularly given annuity rates are currently so dismal.
The alternative is drawdown - a plan where you carry on investing your pension pot and take an income from it. The level of income depends on how your investments are doing and is subject to minimum and maximum limits set by the government.
What happens to my pension when I die?
One of the major downsides of buying an annuity is if you die within a few years of retiring, the insurance company get to keep your money and you end up leaving nothing for your children or your partner. You can buy a joint life annuity which means that if you die before your spouse, they get the pension until they die - but this option comes at a premium. A 65-year-old man with a spouse three years younger than him would typically see his rate drop half a percentage point - for example from 6.1 per cent to 5.6 per cent - to secure the pension for the rest of her life, in the event that he dies before her.
The other "add-on" you can buy for your annuity is a lifetime guarantee, which means if you die before the end of your guarantee, the amount you would have received in income up until that point is paid into your estate. This extra level of insurance doesn't come free though. A 65-year-old man buying a level annuity would normally get a rate of 6.17 per cent - that would be reduced to 6.15 per cent if he guaranteed it for five years, and lower still at 6.07 per cent if he guaranteed it for 10 years.
But if you’re in drawdown and you die, your spouse can use your pension pot to draw income until they pass away. This comes at no extra cost - but the income has to go to your spouse until she or he dies, and the same rules and charges will still apply. If you want your kids, or anyone else to inherit the money when you die, they can receive a lump sum - but they will be charged an eye-watering 55 per cent tax on it.
Would you prefer flexibility or security?
Generally, people choose annuities if they want the security of a guaranteed income for the rest of their life. Drawdown, on the other hand, offers you more flexibility as you can tailor the size of the income you take from your pension pot to suit your needs.
The maximum income you can take from a drawdown pension plan is based upon a number of factors, including your age, gender and the current Gilt Index Yield. Drawdown rules have recently changed to allow you to take a maximum of 120 per cent of the equivalent Government Actuary's Department (GAD) rate annuity, meaning you can have a higher income from your pot. And you can also take a 25 per cent tax-free lump sum at the beginning. However, the more income you take, the more risk you run of eating your pot down to the skin and the bone - especially if your investments haven’t been doing so well. Its also worth knowing you can choose to annuitise your pot at any point.
Annuities are different though, because once you’ve bought one, you’re stuck with it. They do come with options that make them more flexible - such as index linking - which means your income goes up with inflation, which will benefit you if the index rises, but you have to take the hit of a lower rate to start with. A male retiring today aged 65 would get a rate of 6.1 per cent for a single life level annuity. But throw inflation linking into the mix, and his initial rate will drop to a measly 3.6 per cent, according to Hargreaves Lansdown figures.
Consider your state of health
If you know you’ve got health problems or you smoke, your life expectancy might be lower than average, and this affects how you should plan your retirement income.
By applying for an enhanced annuity you could get a lift of up to 60 per cent on the rate you receive. There are a whole host of medical conditions that will entitle you to a better rate and these range from diabetes and heart conditions to snoring and even having a body-mass index (BMI) that classes you as ‘overweight’. To get a quote you have to fill in a detailed health form and gather relevant information from your GP for the insurer.
There aren’t any special rules for people with health problems that take out drawdown plans, but if you’ve gone into drawdown and you do fall ill, you can quickly transfer some or all of your pension pot into an enhanced annuity to get some extra security and a higher rate than you'd otherwise get.
