Annuity Optional Benefits

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Annuity Optional Benefits

There are many factors that can dramatically affect the income you receive from an annuity. Some of these you cannot control - such as your age and gender. Some you can - the optional benefits: annual pension increases or a pension that includes your spouse or partner, for instance. Some benefits will considerably reduce your initial pension income, whilst others will have a negligible affect. More importantly the benefits you select need to be appropriate to your needs.

The following headings take you through the compulsory and optional benefits that apply to an annuity, and will help you to compare the income implications.

• Age and gender
• Frequency of income
• Income paid in advance or in arrears
• With or without proportion
• Guaranteed periods
• Payment of the guarantee
• Escalation
• Partner's pension
• With or without overlap
• Annuities for dependants
• Special rates annuities
• Other factors that affect your annuity income

Age And Gender

Your annuity will be paid to you until the day you die and, if you have a joint life annuity (also referred to as a spouse's or partner's pension), then until both of you have died, so your life expectancy has the greatest influence on the basic level of pension available to you. For example, a 60 year old would receive a lower pension than a 70 year old with the same fund size, because the 60 year old will have a longer life expectancy. And because women tend to live longer than men, they will accordingly receive a lower pension than a man of the same age. If you select a joint life annuity, your partner's age will affect your annuity.

Frequency Of Income

A pension is normally paid monthly, but can be paid less frequently, such as quarterly, half-yearly or even annually. You can choose a time-scale to suit you.

Income paid monthly in arrears is around 4% less than annual in arrears

Advance Or Arrears Payments

Payments can be made either in advance or arrears. If you take out a monthly annuity on 01 July and you receive your payment on that day, you are being paid in advance. If your first payment is not made until 01 August, you are being paid in arrears.

Income paid monthly in arrears is around 1% more than monthly in advance. However, an annuity paid annually in arrears pays around 8% more than one paid annually in advance.

With Or Without Proportion

Another choice, but only for those paid in arrears, is to have an annuity with or without proportion. When you die, an annuity with proportion would pay an amount proportionate from the last payment until the date of death. This is usually only effective for payments made quarterly, half yearly or annually in arrears.

This option would normally have a negligible impact on pensions paid monthly, but would rise quite substantially on those paid annually. This is a valuable option for those being paid annually in arrears, since death just before a payment was due would result in considerable loss of income.

Guaranteed Periods

A guaranteed annuity will make payments for the guarantee period - generally 5 or 10 years - even if you die within that period. Regardless of the guarantee period, you will always receive income until your death. UK IFA Net Ltd believe an annuity with a guarantee is suitable for those with dependants who want the income to continue after their death. Remember that the lower the expected life span, the more expensive a guarantee will become.

The cost difference is also significantly affected by the length of the guarantee. Typically, a man aged 65 could expect 2% less income from a 5 year guarantee than with no guarantee. A 10 year guarantee would pay 6% less.

Payment Of Guarantee

Depending on the type of annuity you have and the type of pension fund it is purchased with, if you opt for a guarantee you may also be able to choose how it is paid. The guarantee may provide either a continuing income until the guarantee period has expired or a lump sum. Any lump sum payments are normally subject to a one-off tax charge, currently 35%.

Escalation

An escalating or indexed annuity is one that increases each year. Choosing this option will result in a considerably lower starting income than having a level annuity. The greater the escalation, the lower the initial income. It is therefore important to balance carefully what you need now against what you are likely to need in the future, and also take into account the age to which you expect to live, based on your health and your family's history of longevity. Typically, a 65 year old man would be in his 80s before the total payments from an escalating annuity matched those from a level annuity. It should be noted, however, that the average 65 year old male is now expected to live well into his 80s. And even 15 years of inflation averaging only 2.5% will reduce the buying power of £1,000 to just £684. Escalating annuities can offset the effects of inflation in later years. You can choose to have your annuity linked to the RPI, (Retail Prices Index) in which case your income will increase in line with inflation (full inflation proofing). You can also have your annuity escalate by LPI (Limited Price Index) which will ensure that it increases annually by 5% or by the RPI, whichever is lower. With RPI annuities your income will decrease if there is negative inflation. Alternatively, you can opt for a percentage of fixed escalation between 0% and 8.5% per annum unless you have a "no reduction" guarantee.

Escalation: The Effects Of Inflation

Because you may be in retirement for many years, UK IFA Net Ltd believe it is extremely important to consider the effects of inflation on your retirement income. In times of low inflation, we believe you should always consider the potential impact of high inflation on your future income should this occur during your retirement. We sometimes forget that as recently as 1990, inflation reached 10.9 %, and that a male aged 65 is likely to live for a further 19 years and a female aged 65 for another 22 years. As a result people retiring now will be faced with the possibility of high inflation in the future.

Many people do not take this into account. Even inflation of a mere 2% or 3% per annum over 10 years will make a difference! Just consider what would happen if inflation were to rise to anything near past levels. As an example, in the period 1970 to 1991, inflation in the UK reduced the value of one pound (RPI adjusted) to just 11 pence. Or, put another way, it would have reduced an annual income of £10,000 to just £1,100.

However, inflation-proofing your annuity can be prohibitively expensive, so much so that, in some cases, full inflation proofing might not be affordable. You could, however, still take an annuity that escalates annually at a fixed rate, even only 1% p.a., as some protection against the ravages of inflation. The lower the annual escalation rate, the lower the cost.

Escalation: Case Study

A male, retiring at 65, is looking at the long-term implications of his retirement income.

For a purchase price of £100,000 he was quoted a gross level annuity, paid monthly in arrears, of £8,859 and of £5,669 for one escalating at 5% per annum. He calculated that he would probably receive the same cumulative income from the escalating payments as that from a level annuity over his expected life span. As he is a disciplined saver, he opted for the level annuity, with the intention of saving the difference between the level annuity and the escalating annuity for any unexpected expenses later on in life (please note that the figures shown are for illustration purposes only).

Any retiree who wants to offset the effects of inflation, and who is not a disciplined saver, should consider some sort of escalation on their pension annuity.

Partner's Pension

This option is not usually relevant to single people but most couples choose to have a pension that benefits their surviving spouse or partner. This option means that, when you die, an income is paid to your surviving partner for the rest of his or her life. Your partner need not be your wife or husband; any person of either sex may be eligible for a partner's pension, although some companies will insist that you can show that person's financial dependency on you. Financial dependency may also need to be proven if, and when the dependant's annuity comes into payment. The 'partner's pension' is sometimes called a 'spouse's pension', or a 'reversionary pension' because the income reverts to your partner.

With some company pension schemes, a spouse's pension must automatically be included; this is also currently the case with protected rights pensions.

Your customer service consultant at UK IFA Net Ltd will be pleased to answer any questions you may have regarding your partner's pension.

Cost Comparison

The chief factor affecting the costs is the age of your spouse. If you, as the main annuitant, are a man and your wife is your age, the mortality factor will automatically reduce your income slightly. If your wife is considerably younger than you, this can have a large impact on your income, especially if you choose a 100% spouse's pension. For a man aged 65 with a wife aged 62, the starting income would be around 14% less, than a single life annuity, if he chose a 50% benefit for his wife. This income would fall to around 24% less with a 100% spouse's pension. Most couples, however, opt for an income between 33% and 66% of the annuitant's pension.

Partner's Pension: Case Study

A man aged 65 with a wife aged 62 needs to calculate the level of pension his wife will need on his death, and also how that would affect the starting income for them both. For a single life annuity costing £100,000 he was quoted an income of £8,859 per annum. This was reduced to £7,652 and £6,741 with a spouse's pension of 50% and 100% respectively.

With Or Without Overlap

This is usually only available to retirees from company pension schemes where a 5 year guarantee period and a spouse's pension are required.

Otherwise, all pensions are paid 'without overlap'. If the annuitant dies within the guarantee period, 'with overlap' means that the spouse's pension starts immediately and is paid in addition to the remaining guarantee period pension. 'Without overlap' means that the spouse's pension does not start until the guaranteed period pension finishes.

Cost Comparison

When you are able to choose 'ith overlap' you will find it relatively expensive. For a pension with a 50% spouse's benefit, and a 5 year guarantee period, the reduction in the annuitant' income would be roughly 1.5 %.

Annuities For Dependents

It is possible to provide protection for dependants other than your partner, such as children in full time education; children with special needs, and elderly relatives who are financially dependent on you. Once again financial dependency may well need to be proven if, and when the dependant' annuity comes into payment.

Cost Comparison

This type of annuity can result in a large reduction in your income, and is not offered by all annuity providers. However, if you feel you need this protection for your family, we can arrange some special quotations for you.

Special Rates Annuities

If you smoke 10 or more cigarettes per day and have done for the last 10 years, you may qualify for enhanced annuity rates. These rates can make quite a substantial difference to your retirement income. If you stop smoking after you have purchased your annuity your income will not be affected. Similarly, if you are in ill health or have had any previous illness or major surgery which is likely to reduce your life span, again you may qualify for enhanced annuity rates. These types of annuities can take longer to set up than normal, as correspondence between your doctor and the annuity companies will often increase the administration time by a few weeks. The illnesses include diabetes, liver impairment, hypertension which cannot be controlled by medication, heart conditions and any type of cancer, whether or not you are in remission. Some illnesses can result in a significant increase in your income. If you are including a spouse' or partner' pension, his or her health should be assessed, because it may improve your income.

Another type of annuity is the socio-geo-economic annuity. If you are in a manual occupation or if physical labour accounts for a large part of your work, and you live in certain areas of the UK, you may qualify for this annuity, which tends to offer a higher annuity rate than the top standard annuity rate available.

Other Factors Affecting Income

Annuities, like most other products and investments, are also affected by current economic conditions. The income returns from annuities reflect the current economic conditions at the time. In times of low inflation and high share markets, annuity income is generally lower than at times of high inflation and low share markets.

Investment linked annuities carry varying degrees of risk, but are an alternative to a standard annuity.

Investment linked annuities are available to retirees with personal pension plans, and are not usually accessible by retirees from company schemes, unless they transfer into a personal pension plan, or the rules of the scheme permit such annuities. There may be restrictions on the income payable from investment linked annuities purchased from company pension schemes.

It always pays to take advice if you want to know more about the benefits of each individual plan.

UK IFA NET provide fully independent Annuity Advice for your individual requirements. Simply click for a quote. Alternatively speak to one of their highly experienced consultants today on 0845 365 2410 quoting ref WS9 or fill out our online quote request form and one of their advisors will contact you.