How to choose an annuity

MrsJ is at the point of deciding what to do with a part of her pension pot. One of the options is to buy an annuity but since neither of us has done that before we aren’t really sure how to judge if it’s the right thing to do(*), and if so, how to choose a provider and what to look out for. I’d appreciate any tips from financially savvy STWers!!

(*) a big part of this for her is security – she doesn’t want to be scanning the Financial Times and worrying about pork belly futures (except in so far as that describes my waistline)

I guess the standard answer is speak to an IFA.

However good luck finding a good IFA who will work in your interest,

Its very individual and depends on a large number of unique factors. As above you can try to find an expert who you can work with or you can learn yourself (and its probably never been easier to go down this route) and accept the risks.

I’m lucky enough to have 3 final salary pensions (2 are quite small and 1 is of reasonable value) which gives us a safety net and Mrs Surfer will retire end of 2026 and she has 1 generous final salary plus a generous DC scheme from her current employer. We also both have reasonable amounts in our SIPPS and ISA’s.

We took the view that because both of us are active and we are both retiring relatively early that we wanted to front load our spending as oppose to having a guaranteed smaller amount forever. You may feel differently and its very much dependent on your own circumstances. I watched my mum lose all of her savings and the family home when she went into care, albeit with quite a generous amount of money coming into her account each month that she felt no real benefit of for her remaining years. We are watching the same thing with my wife’s parents.

Obviously an IFA is the place for proper advice.

However,  current annuity rates don’t look great. I quoted for a 64 year old male with £100k and got offered £5700 a year or 5.7%. So I would need to live past 80 to get my money back. Bear in mind though that the £5700 is all taxable if you  have other income of £12k including an old age pension. Taking tax into account it would be 23 years before I got my cash back. 87?  Do I feel lucky?

Another way to look at it is I could get 5% in an ISA tax free for  £20k every year. So that is a higher income than the annuity taking tax into account. Plus your capital is still there.

So, obviously dont buy an annuity unless your ISA is maxed out every year first.

Thereafter if you could get 5% sticking the rest in a savings account and keep the capital  you are not gaining that much from an annuity.

I suppose you could argue that an annuity locks an interest rate in but historically 5% is not a high interest rate. The past few years of lower rates were an anomaly.

First off, has she spoken to Pensionwise? It’s free and should be impartial.

After that, it depends on so many things – other sources of funds, risk appetite, do you want to have anything to leave to children…

Personally I’ve decided not to buy an annuity because I have other sources of income and therefore the certainty an annuity provides is not crucial for me. So far that’s proved to be the right choice, but a market crash could well change my opinion on that. If you do decide to go for an annuity, it’s really important to shop around as rates can vary significantly and you may get a better income that you are offered by your current pension provider – but equally they may offer some incentives you can’t get elsewhere. Also look at the indexing options and whether you want a survivor’s pension. Good luck!

Another way to look at it is I could get 5% in an ISA tax free for  £20k every year. So that is a higher income than the annuity taking tax into account. Plus your capital is still there.

You may be assuming that the money to purchase the annuity is cash, as oppose to already within a SIPP. If in a SIPP then removing that to invest in an ISA (and benefit from the interest rate) will have tax implications.

Historial annuity rates

Billy Burrows: What next for annuities?

Annuity rates are the highest they’ve been for 15 years.  You can currently get c5% from a cash ISA but that hasn’t been true for many years before now and might not be true in future.

My provisional plan is to have a mix – some locked in income from annuities alongside drawdown,

If security is a big part of it for her, then I think an annuity is a good way to go as long as it’s giving you a decent amount of income.

You may not want to use all of your pension savings for one though?

To be honest, IMO loads of financial advice on the internet, including on here is too focused on not missing out on best case scenarios, rather than looking at preventing worst case scenarios.

This is so driven by your individual and collective financial positions and attitude to risk.  There are many types of annuity out there – such as different payout profiles (between relatively high but level payouts and lower payouts with some sort of annual uplift mechanism), different possibilities upon the death of the annuity holder, and even fixed term arrangements with a value on maturity.  The answer also depends on whether this is a company DB scheme, where many offer the chance of a cash pot (which could then be put into an ISA, for example), or whether this is part of a drawdown in a SIPP arrangement.  Despite Rachel Reeves’ changes SIPPs remain tax advantaged for tax free returns, so the advice probably favours retaining money in there but for peace of mind that there is some income maybe consider a monthly drawing on the SIPP which can be part tax free and part taxable.  And max out the ISA contribution.  IANIFA.

You may be assuming that the money to purchase the annuity is cash, as oppose to already within a SIPP. If in a SIPP then removing that to invest in an ISA (and benefit from the interest rate) will have tax implications

This.

@irc you seem to have neglected the fact that the money is currently in a pension. The OP’s wife can’t just take it out of there and slap it in an ISA.  She has to pay tax on most of it however she takes it.

( Yes, 25% tax free lump sum notwithstanding)

If you do decide an annuity is the answer for your own reasons, it’s reasonably easy to get quotes from a variety of providers by using the tool at moneyhelper.org.uk/guaranteed-income. Put your various preferences and the value of the DC pot(s) into that, and it’ll spit out a series of about 5 or 6 quotes from each of several potential providers.

Meant as fyi.

Presumably you’ve done your wills and are aware of the change this might mean. (Roughly speaking what is left in the pot can be left as part of the estate with an annuity the pot is empty)

Somebody has done the maths bit above, so , sorry, again sorry, but how long did her parents and close relatives/siblings live and do your own money maths

Somebody has also mentioned pension wise, I’d also recommend them but as you only get 1 free hour I’d suggest doing quite a bit of your own research etc first, to understand exact financial position, all monies, all debts, required pension income etc etc etc.

FYI , You take 25% of total tax free or as I do take 1 pension income per year of which 25% is tax free, which might give a tax advantage over an annuity. Also you can (*beware tax implications ) take different pension amounts each year, an annuity will be a lot less flexible (*but as you say is derisked and easier)

Check out how the pension pot has done over the last x, 10, 5, 3, 1 years. Then compare it with market averages etc as well. Past performance may not be repeated though. Has the pension company said anything about altering the profile/portfolio/risk status (*very roughly you can take more risks when young as time to recover, as you ages the investment portfolio is usually/often/maybe (some of mine were) automatically changed to decrease the % in riskier investments and move to more stable (but generally less growth) investments.

Make sure you understand what the annuities do about inflation and what the limits are. Also have a look at the impact of delaying taking them.

* I didn’t do an annuity (my personal money maths, flexibility as I have other income, pension co performance has been better than annuity, )

FYI , You take 25% of total tax free or as I do take 1 pension income per year of which 25% is tax free

can you explain that – new to me

25% of your pot is tax free j*subject to LTA max)

You can take the 25% as a lump sum or bit by bit.

So I could have taken 25% of my total pot at start tax free and then the rest as taxed income.

I took 0% of my pot tax free at the start and each year I take a single amount out of my pension and I can get 25% of this tax free. (E.g if I took out 26,000, then 6590 is tax free, rest is taxed).

Look up ufplus.

https://www.hl.co.uk/retirement/ufpls.

I’m not saying it’s a good idea, but everybody has different circumstances and in my particular case I think it’s the best choice.

If you’re not going for an annuity then this means you’re keeping your money invested, in which case limiting the tax free amount you remove at the beginning is beneficial because more stay invested, and the remainder of the 25% you’re still entitled to is growing too, meaning overall you’ll end up claiming a larger amount tax free as well.

One reason to consider a monthly draw rather than annual lump sum is that any interest earned on the lump sum outside of the SIPP before it is spent is itself taxable, but a monthly draw allows the interest earned inside the SIPP to compound tax free.  In round numbers, assuming no other income, you can take c£16k pa tax free (25% is free of tax and the remainder is equal to the individual allowance).  If the £16k is drawn at the start of the year, unless it is all spent in one go some of it will accrue interest which will be taxable (this is for illustration as there is an interest earned allowance), whereas a draw of £1,333 per month will not attract income tax and the interest will roll up tax free within the SIPP.  The same idea can be applied if there are already other earnings and you might want to draw up to the upper end of the basic rate band.

@blackhat Assuming you are a basic rate tax payer and that you spent your £16k evenly over the 12 months, you would have to be earning an interest rate on that reducing cash balance of over 12% in order to breach the £1k pa interest limit.

hence the brackets noting it is for illustration.

The two key things to note are that:

#1 You can’t buy history

#2 Everyone is different

Based on the above getting advice that’s specific to the individual is the most important action.

I like many was all set on taking my 25% tax-free as a lump sum and then I watched a video explaining how it might be better to take 25% tax free from every payment.  It made me realise just how important #2 is.

I still haven’t worked out my strategy, but as I’m still working I don’t really have to.

I will though be in receipt of a couple of pension payments from next month as they payout from 60 y/o with no option to delay; I’ll just be paying some additional tax as I’m a high-rate tax payer (from my job) – unless someone tells me otherwise (back to #2 🙂 ).

this is a great thread, some really useful info and ideas.  I am a couple of years away from retirement so read these threads avidly.  I will likely use an uncrystallized draw down arrangement when the time comes, however, one query I do have, and it’s on my list for my next call with my IFA – I am likely to receive an inheritance in the next year of a sizeable amount, possibly up to 2-300K, which will be tax free as under the IHT limit.  I am likely to still be working at that stage, and already max out my annual pension contributions and ISA allowance, so my loose plan could be to retire within a year or so thereafter, and use the inheritance, however invested, as income until it runs out, then the ISA , and finally start to drawdown on the pension, so leaving that to continue to grow for as long as possible, which with a fair wind might also get me to state pension age.

This seems an ok plan, and obviously subject to advice from an IFA, but I am curious as to how such an inheritance is viewed by the tax man once it is reinvested and gradually spent, say over 5 years, with the remaining and gradually reducing pot being invested and growing – does it become taxable income ?

This seems an ok plan, and obviously subject to advice from an IFA, but I am curious as to how such an inheritance is viewed by the tax man once it is reinvested and gradually spent, say over 5 years, with the remaining and gradually reducing pot being invested and growing – does it become taxable income ?

If you just put it into a Bank Account and spent it over the 5 years there would be no tax to pay on the money you took out, but any interest would be taxed (as per any Bank Account).

If you ‘invested’ it in ‘something’ then standard investment rules would apply, irrelevant of where the money original came from.

If you’re flush with cash due to the inheritance (which seems likely) over the next year or two you can max out pension contributions out of your earned income, thus saving the tax on that.

Anything you inherit is automatically free from tax – if IHT was due it gets paid out of the estate before you inherit. Any income or growth from investments is however potentially taxable.

Thanks, yes, that is now clear to me.  As i mentioned in my post I already max out pension contributions from earnings, via a salary sacrifice workplace pension that I transfer annually to a SIPP, however that would stop when I retire.  Some more ideas added to my IFA discussion list, thanks all

 a big part of this for her is security – she doesn’t want to be scanning the Financial Times and worrying about pork belly futures

This is a good reason to go for an annuity, but nobody so far has mentioned what type of annuity. Most annuity quotes are for a fixed amount per year, or with a fixed percentage increase per year (e.g. 3%). In both cases you are bearing the risk of inflation (albeit less so with the 3% escalator). We have been living in a low-inflation environment for such a long time that people have got used to it, but we had a year of 10%+ inflation very recently which permanently reduced the number of Mars bars such annuity holders can buy per year (i.e. spending power). If you really want security from an annuity it’s worth seeking out one that has inflation protection built-in (i.e. index-linked) – these are more expensive and relatively rare, but they are available and only they will give you cast-iron certainty that the amount you are getting this year will still buy the same number of Mars bars in 15 years’ time.

I have a decision to make on an annuity too,  my ex employer has offered a generous uplift if I buy through them, like 2 percentage points, so that swings it for me if true.

The other choices are the term, 10 years, 20, death, indexing.

I haven’t made a decision on that, but a mate took a pension that finishes at 80 and he s fighting fit, aged 79, he s really miffed.

For me it’s a small, but welcome part, of a retirement portfolio.  I paid in q alot and it’s actually performed well, it was very tax efficient too.

I will research quotes online before committing.

I’d never consider an annuity. Rates are poor at the moment even against historical averages.

I plan an income drawdown via the three buckets approach. But as always a good IFA would be best to advise for their circumstances.

Somebody has done the maths bit above, so , sorry, again sorry, but how long did her parents and close relatives/siblings live and do your own money maths

Trying to do actuarial statistics just based on your immediate family is probably not particularly robust.

We have been living in a low-inflation environment for such a long time that people have got used to it, but we had a year of 10%+ inflation very recently which permanently reduced the number of Mars bars such annuity holders can buy per year (i.e. spending power). If you really want security from an annuity it’s worth seeking out one that has inflation protection built-in (i.e. index-linked) – these are more expensive and relatively rare, but they are available and only they will give you cast-iron certainty that the amount you are getting this year will still buy the same number of Mars bars in 15 years’ time.

A very valid point, although you might want to consider whether you expect to buy as many Mars Bars at 80 as you do at 65.   That will depend on all sorts of personal lifestyle factors, physical health, perhaps children/grandchildren etc.   (of course you may or may not have “old age” related costs rather than luxury lifestyle ones).  There is no certainty that the triple lock will continue – but I think most people getting old age pension today can probably expect some degree of inflationary increase over time.  If that makes up say 70% of your retirement income, having the last 30% also index-linked may be less of a priority.  On the other hand if that is actually a small part of your total income you may notice inflation far more if your annuity does not keep pace with it.

Perhaps also worth considering that if you do anything complicated (ie. not simply drawing down an annuity) and then you fall into the world of lasting power of attorney etc – your attorney may not share the same view on the best approach to your investments.

Trying to do actuarial statistics just based on your immediate family is probably not particularly robust.

Sadly there may be instances where this is exactly the right approach, as oppose to relying on actuarial statistics.

Lots to think about here – many thanks to everyone – it’s appreciated 🙂

I’m planning a potential exit next year and there are quite a few permutations of what can be done and the impacts of these are. Suggest use the calculator link below will give you a easy comparison of your possible options.

https://www.legalandgeneral.com/retirement/pension-annuity/pension-annuity-calculator/

A very valid point, although you might want to consider whether you expect to buy as many Mars Bars at 80 as you do at 65.

Also a very valid point. In my case I will probably look what I need to live on (i.e. covering essential bills and a basic food allowance) and buy an index-linked annuity to cover the gap between state pension and that minimum. The rest goes into a SIPP and what I take from that will depend on the funds’ performance each year. Likely starting point for the SIPP will be 60:40 equities:gilts, drawing down from the gilts and buying more gilts from the equities when the equities have a good year. Drawing down between 2% and 6% each year should give a good balance of lifestyle and income security over a 40 year retirement.

Suggest use the calculator link below will give you a easy comparison of your possible options.

https://www.legalandgeneral.com/retirement/pension-annuity/pension-annuity-calculator/

The big danger of this and almost all other such calculators is that they tell you how much you get each year, but there is no inflation protection built in. In other words, your “real” income (spending power) will decrease with inflation each year. Imagine doing this in the 1970s – you’d have been screwed. And there’s no particular reason why there couldn’t be another high-inflation period at some point during a 30-40 year retirement (you might die at 84 on average, but there’s a 5-10% chance you could live to 100 or so).