Authority (FSA) is the FSA guide to annuities and income withdrawalwebarchive.nationalarchives.gov.uk/20060213205517/fsa... · · 2005-03-13FSA guide to annuities and income withdrawal

FSA guide to annuities andincome withdrawal

Financial ServicesAuthority

January 2004

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Contents

Introduction 3

Why do I need an annuity? 5

Choosing the right annuity 8

The main types of annuity: 10

– How annuity rates vary – accordingto age, sex and type 13

– Level annuities 14

– Increasing annuities 15

– Annuities if you have a partner 17

– Investment-linked annuities 20

Retiring gradually 26

Income withdrawal 28

Where to buy annuities 31

Where to get advice 34

Complaints 36

Useful contacts 37

Check annuity rates online at www.fsa.gov.uk/tables 1

Asking the right questions.

The FSA – here to help you make

more sense of your money

The Financial Services Authority (FSA)is the independent watchdog set up bygovernment to regulate financial services and protect your rights.

By law, most financial services firms must be authorised by the FSA. We aim to ensure that all firms we regulate are run in a prudentand financially sound way, and regulate the waymany of them do business with you.

Firms established in another EuropeanEconomic Area (EEA) state are authorised bythat state although the FSA may regulate someaspects of the way they do business with you.

Always check that the firm you are dealingwith is authorised. Solicitors, accountants andactuaries do not need FSA authorisation tocarry on a limited range of financial services sosome of them will not be FSA authorised.


Introduction

A guide to making decisions about buying an annuity if you are retiring soon.

What is an annuity?

An annuity is a special investmentsold by insurance companies. It is away of converting a lump sum, usuallythe pension fund you built up duringyour working years, into an incomeduring your retirement.

Check annuity rates online at www.fsa.gov.uk/tables2

This booklet is an introductory guide that outlines the mainways of converting your pension fund into an income foryour retirement. It is general information designed to helpyou ‘ask the right questions’ and so make informeddecisions and the right choices.

For financial advice specific to your individualcircumstances, you should consult an authorised financialadviser. For help in finding one, see the FSA guide tofinancial advice or visit the FSA website atwww.fsa.gov.uk/consumer

Information in this booklet is based on the legal and taxposition at December 2003.

The government announced in December 2002 proposals toreform the pension taxation rules. One of its proposals isthat the earliest age from which a personal pension may betaken should increase from 50 to 55 by 2010.

You can see these proposals on the Department for Workand Pensions website at www.dwp.gov.uk or call the DWPOrderline 020 8867 3201 for a copy. This booklet is for you if you will get

your retirement income from:

■ a personal pension;

■ a stakeholder pension scheme;

■ a group personal pension planarranged through your employer;

■ a retirement annuity contract(similar to a personal pension butsold before July 1988 whenpersonal pensions first becameavailable);

■ the type of additional voluntarycontribution (AVC) scheme thatbuilds up your own investmentfund;

■ a free-standing additional voluntarycontribution (FSAVC) scheme.

This booklet may also be relevant if you will be getting retirementincome from:

■ the type of employer’s pensionscheme that builds up your ownretirement fund – called a definedcontribution or money purchasescheme;

■ a Section 32 policy – if you haveused this to transfer out of youremployer’s pension scheme.

HeadWhy do I need an annuity?


An annuity is a special type ofinvestment because, apart from atemporary annuity, it will pay you an income for the rest of your life. Unlike other investments, it cannot be used up, however long you live,neither can it be stopped or sold.

Pension plans and schemes aregenerally a good way to save forretirement because the governmentgives you tax relief while your savingsbuild up. But the government alsorestricts how you can use those savings– called your ‘pension fund’ – whenyou decide to retire.

Often, you can take up to a quarter ofthe pension fund in cash, as a tax-freelump sum. The exact amount dependson Inland Revenue rules – ask yourpension fund administrator how muchyou are entitled to. The remainingfund must be used to provide taxableretirement income.

Many people invest their tax-free cashelsewhere, either to provide moreincome or for capital growth.

If your fund is from a pension top-upscheme, such as an AVC or FSAVC,you must usually use the whole fundto buy an annuity. Tax-free cash isonly available if you started payinginto this kind of scheme before 6 April1987. Very small pension funds cansometimes be taken as cash (ie youdon’t need to buy an annuity).

By law, with some exceptions, eventually youmust buy an annuity with your pension fund.


This booklet does not apply to anyfinal salary (defined benefit) pensionsunder an employer’s pension scheme.In these schemes, your income inretirement is provided by your pensionscheme and you do not need to buy an annuity yourself. But you may, ifyou wish, buy a ‘purchased lifeannuity’ with your tax-free cash sum –see page 6.

You will have some importantdecisions to take as you approachretirement that should include yourpartner. For example:

■ how to provide an income for yourpartner after you die;

■ whether to protect your incomeagainst inflation;

■ whether you are willing to exposeyour income to investment risk.

This booklet outlines the mainchoices available to you and highlightssome of the things you will need tothink about.

You should also read the FSAfactsheet Your pension – it’s time to choose available from ourConsumer website or Helpline– see Useful contacts page 37.

Start thinking about your annuity choices

at least four months before you retire.


Purchased life annuities

Even if you need income, it is oftenworth taking the maximum tax-freecash sum, though this is not alwaysthe case so take advice. You can useit to buy a ‘purchased life annuity’.This is similar to the pensionannuities described in this bookletbut a purchased life annuity istaxed more favourably.

You can also buy a purchased lifeannuity with any other fund ofmoney (annuities bought from yourpension fund are called ‘compulsorypurchase annuities’).

Remember though that once youbuy an annuity you can’t normallyconvert it back to cash.

Open market option

You are free to buy an annuity fromany insurance company. You don’thave to buy it from the companywith which you built up yourpension fund if you can get a betterannuity rate elsewhere. You cancheck annuity rates on the FSA’scomparative tables website atwww.fsa.gov.uk/tables


There are two ways of converting yourpension fund into retirement income.You can:

■ buy an annuity; or

■ choose ‘income withdrawal’ beforebuying an annuity.

Buying an annuity

After taking any tax-free lump sum,you use the whole of your remainingpension fund to buy an annuity froman insurance company. The annuitythen pays an income for the rest ofyour life. Once you’ve bought anannuity, you can’t get back any of yourpension fund as a lump sum, but theannuity will carry on paying out –however long you live. It will stoppaying out on your death, unless youtake out a joint-life annuity or onewith a guarantee period. See pages 17 to 19.

There are different types of annuity –see pages 10 to 25 for help choosingbetween them. And, like most things,it often pays to shop around for thebest rates – see pages 31 to 33.

Government rules currently say that(after taking any tax-free lump sum)you must use all your pension fund tobuy an annuity by age 75 at the latest.If you have more than one pensionplan or scheme, you don’t have to buyan annuity at the same time from all ofthem, though you might be able to getbetter rates by combining them – see page 33.

Income withdrawal

Instead of buying an annuity straightaway, you can leave your pension fundinvested and draw an income direct fromthe fund. Normally, you should onlyconsider doing this if your pension fundis more than £100,000, after you havetaken any tax-free cash. Page 28 explainsmore about income withdrawal.

At any time, you can stop incomewithdrawal and buy an annuityinstead. In any case, you must use allthe remaining fund to buy an annuityby age 75 at the latest.

When your pension starts

Under current government rules,you can normally start to take apension at any age between 50 and75 – though your own scheme mayfix a particular age somewherebetween these limits.

Check annuity rates online at

www.fsa.gov.uk/tables

■ you want to prepare for futurehealth needs.

In later retirement, you might needmore income than you did at theoutset, to help you cope withdisability or health problems. This is another reason to consideran annuity that increases over theyears – see page 15.


Obviously, you want to retire on thehighest pension you can get. Butdon’t just look at your circumstanceson the day you retire – think aboutyour own future needs and those ofyour family.

Start thinking about your annuity choices

at least four months before you retire.

Choosing the right annuity

Check annuity rates online at www.fsa.gov.uk/tables

With some annuities there is achance of your income going down,as well as up, so you need to thinkabout whether you can afford thisrisk – see page 20.

Because there are many differentsorts of annuities, you need time tochoose the one that best suits yourneeds, and to shop around for thebest deal – see page 31.

8

The many different types of annuityare described on pages 10 to 25. Whatkind of annuity you choose dependson your particular circumstances andneeds. But a very important factor inyour choice is your attitude to risk.

The type of annuity you choose at theoutset, and the benefits it provides,will affect the amount of income youget, both initially and over the years.Because you can’t normally changeyour annuity once you’ve bought it, itis vital to check all the options so youbuy the one that best suits your needs.

Normally, taking care of the long-termfuture means accepting a lowerstarting income from your pension,but this will usually be worthwhile if:

■ anyone is financially dependenton you.

If you have a wife, husband, otherpartner or child who is financiallydependent on you, you shouldnormally buy the type of annuitythat will give them a pension whenyou die – see page 17.

■ your pension is a main source ofincome.

Consider annuities that mightprotect your income against theeffects of future inflation – seepage 15. If you don’t, you maystart off with a higher income inthe early years of your retirement,but you will be able to afford lessand less as time goes on.

The choices you make now will affect you – and your partner – throughout retirement.

Check annuity rates online at www.fsa.gov.uk/tables 11Check annuity rates online at www.fsa.gov.uk/tables10

Annuity rates are usually quoted for a man or woman of a given age.

Usually, the starting income from the same size of pension fund is higher for a man than for a woman.This is because, on average, the lifeexpectancy of a man is less than thatof a woman of the same age.

All annuities have one feature incommon: the income you get at thestart is higher the older you are. This isbecause, on average, an older personhas fewer years left to live than ayounger person. So an older person’spension fund does not have to last solong. The summary chart on page 13shows you how rates vary accordingto your age, sex and the type ofannuity you choose.

If you die soon after buying anannuity, it will not have paid outmuch. To guard against this, you canchoose an annuity with a guaranteeperiod – see page 18.

You can usually choose to have yourincome paid every month, every threemonths, every six months or once ayear. You can also usually choose to be paid in advance or in arrears. You normally receive less if youchoose payment in advance.

Take time to explore your options –and seek specialist financial advice ifyou need it – see page 34.

Impaired and enhanced annuities

Some companies offer annuitiesthat pay you a higher-than-normalincome if you have a healthproblem that threatens to reduceyour lifespan – these are called‘impaired-life annuities’. Relevanthealth problems might include, forexample, cancer, chronic asthma,diabetes, heart attack, high bloodpressure, kidney failure, multiplesclerosis or stroke.

You might be able to get an‘enhanced annuity’ if you areoverweight or smoke regularly.Some companies offer better ratesto people who have followedcertain occupations, and toindividuals living in certain parts of the country – shop around!

The main types of annuity

The next few pages describe the maintypes of annuity:

■ level;

■ increasing;

■ annuities if you have a partner; and

■ investment-linked;

and how they can meet your need forincome during your retirement.

How annuities work

The amount of income an annuityprovides each year in return for thelump sum from your pension fund iscalled the ‘annuity rate’.

The amount of income an annuity will pay depends on:

■ the amount you have in yourpension fund;

■ the amount of tax-free lump sumyou take (not usually available with AVCs or FSAVCs);

■ the annuity rate offered by theinsurance company;

■ your age, your sex and your healthat the outset;

■ the benefit options you choose,such as whether it is just for you orfor a partner as well.

The income you get from your annuityis taxable.

There are different annuities to suit different needs.

New types of annuity products arebeing developed all the time, somake sure you are aware of all theavailable options and takespecialist advice if you’re not sure.

Notes to the chart opposite

1. Level (no guarantee period): The income

provided is the same each year for the rest of

your life.

2. Level (guaranteed 5 years): The income is

the same each year but is guaranteed to be paid

for at least 5 years, regardless of when death

occurs.

3. Increasing 3% each year (no guarantee

period): The income increases each year by 3%

but stops immediately on death.

4. RPI linked. The income increases each year

by the retail price index (RPI).

5. Joint lives: On the death of the scheme

member, the income continues (at the level

you select when you take out an annuity) to

the member’s spouse/partner for the rest of

his/her life.

6. Better rates may be available for people

with health problems, or who have followed

certain occupations – see page 11.

7. Source: FSA Comparative tables website.

December 2003. www.fsa.gov.uk/tables

8. The annuity rates in the chart are for illustration

on £10,000 only. The income from an annuity will

vary depending on the sum invested.

You may see an annuity rate expressedas a percentage, or as so many poundsof income for each £10,000 you haveinvested in your pension fund. Forexample, an annuity rate of 6% is thesame as £600 a year income for every£10,000 in your pension fund.

The examples used opposite (andelsewhere in this booklet) are based on annuity rates in December 2003,on the FSA Comparative tableswebsite and are for illustration only.Annuity rates when you retire willprobably be different.

Check them yourself as you nearretirement and shop around for thebest deal – see page 31.


Annuity rates are changing all thetime. In general, the annuity rate at the time you buy your annuitysets your income throughoutretirement. Later changes inannuity rates do not affect your annuity income.

How annuity rates vary – according to age,sex and type.

Level annuitiesLevel (no guarantee period) 53 62 50 56 48 53

Level (guaranteed 5 years) 52 61 49 55 47 52

Increasing annuitiesIncreasing 3% each year (no guarantee period) 38 45 35 41 32 35

RPI – linked(no guarantee period) 36 43 33 39 30 34

Joint lives Joint livesSingle life (no reduction on death (reducing by 1/3 on death

of scheme member) of scheme member)

Male 60 Male 65 Female 60 Female 65 Male 65 Female 60 Male 65 Female 60

£/mth £/mth £/mth £/mth £/mth £/mth

This chart gives an indication of the pre-tax monthly pension income from yourannuity that could be purchased in 2003 for a lump sum of £10,000. The figures inthe joint life columns assume that the person buying the annuity is male and is fiveyears older than his female partner. These figures are only an illustration at onepoint in time, to help give you an idea of what you might get. Annuity rates changefrequently for a number of reasons.

Types of annuities

A level annuity (sometimes called a‘standard’ annuity) pays the sameincome year after year for the rest ofyour life.

The main drawback of a level annuityis that what you can buy with theincome falls as prices rise. For example,suppose at the start of retirement yourgroceries cost £50 a week. If inflationaverages 3% a year for ten years, theircost would rise to £67 a week after tenyears. If you could still afford only£50, you would be able to buy fewergroceries. That’s the effect of inflation.

Is this type of annuity for you?

Level annuities pay a higher startingincome, compared to increasingannuities, which only start to providebetter value some years into yourretirement. But think carefully aboutthis effect. Could you cope with havingno increases at all in your annuityincome during your retirement? If not,check the alternatives using the charton pages 24 and 25.

Check annuity rates online at www.fsa.gov.uk/tables14 Check annuity rates online at www.fsa.gov.uk/tables 15

Example of level annuity

Harry retires at age 60 and has agood chance of living another 25years or more. After taking a tax-free lump sum (see page 5), hisremaining pension fund is £40,000.He chooses a single-life levelannuity with no guarantee period.This pays him around £2,520 a year(£210 a month or £48 a week).

Even if inflation averages just 3%a year, the buying power of Harry’spension would fall dramatically asretirement progresses. After tenyears, his £2,520 annual pensionwould buy only the same as £1,875today. After 20 years, its buyingpower would have fallen to around£1,395 a year. And, after 30 years,its value would be just £1,038a year – well below half itsstarting value.

If inflation is more than 3% a year,the buying power of Harry’s pensionwill fall even further and faster.

Level annuities.

A fixed income but vulnerable to inflation.

To protect your income from risingprices, you can choose an annuity thatis designed to increase each year.There are two main choices:

■ fixed-rate increasing annuities –your income is guaranteed toincrease at a fixed rate each year,commonly by 3%;

■ RPI-linked annuities – your incomeis adjusted each year to reflectchanges in the Retail Prices Index(RPI) – the main measure ofinflation used by the government.So, if inflation is 2% one year, yourincome goes up by 2%. If inflationis 3% next year, your income goesup by 3%. However, your incomeis not guaranteed to increase eachyear – if the RPI did not rise,neither would your income. If theRPI fell, so would your income.

The proceeds of some pension plansand schemes must be used to buy a‘limited price indexation’ (LPI)annuity. With these, your incomenormally rises each year in line with

the RPI but only up to a maximum of5% a year. Unlike an RPI-linkedannuity, your income under an LPIannuity could not fall, even if the RPIdid. Ask your pension provider if youhave one of these schemes or plans.

With an increasing annuity, thestarting income is a lot lower than you would get from a level annuity. For example, for a man aged 60, the starting income from a 3%increasing annuity might be two-thirds or less of the amount from alevel annuity. It could take more thanten years for the increasing income tocatch up, and nearly 20 years beforethe total you’d received from theincreasing annuity exceeded the totalpaid by the level annuity.

Is this type of annuity for you?

You are giving up some income todayto make sure your income holds itsvalue in the future.

You have to live a certain time before the income from an increasingannuity catches up with the amountyou could have had at the outset froma level annuity.

Increasing annuities.

An income with some protectionagainst inflation.

Make sure your partner will stillhave an income if you die.



You need to weigh up whether youthink you will live long enough tobenefit from the protection againstinflation offered by an increasingannuity.

If you’re not sure if an increasingannuity is for you, check thealternatives using the chart on pages 24 and 25.

Example of RPI-linked annuity

Hannah retires at age 60. After taking a tax-free lump sum(see page 5), her remaining pensionfund is £35,000. She chooses asingle-life RPI-linked annuity withno guarantee period. The pensionstarts at £1,428 a year (£119 a month, or £27 a week).

After 10 years, inflation hasaveraged 2% a year. Her annualpension has increased to £1,741a year. This means she can stillafford to buy the same as she didwith £1,428 ten years ago.

Over the next ten years, inflationaverages 5% a year. Hannah’sannual pension increases to £2,836and keeps its original buying power.


Joint-life annuities

Both conventional and investment-linked annuities can be ‘single-life’or ‘joint-life’. See page 20 for anexplanation of investment-linkedannuities.

A single-life annuity pays out onlyduring your own lifetime. Your partner will get nothing when you die.A joint-life annuity continues to pay an income to your partner after your death.

On your death, some annuities carry on paying the same amount.With others, the amount is reduced –for example, by a third or a half. Youusually choose at the outset how muchincome you want your partner to get.If you are not married check with yourprovider that your partner is eligible toreceive it.

With some pension schemes, the lawsays you must opt for an annuity thatprovides a pension for your widow or widower equal to half the incomeyou were getting. Your provider cantell you if this applies to your plan or scheme.

If you have a wife, husband orpartner who is financially dependenton you, you should normally choosea joint-life annuity – unless youhave other assets or income foryour dependants to live on afteryour death.


Annuities if you have a partner


Annuities with a guarantee period

If you die soon after buying anannuity, it will not have paid outmuch. To guard against this, you canchoose an annuity with a guaranteeperiod.

These sorts of annuity commonlyguarantee to pay out at least five or tenyears’ worth of income, even if you diewithin this period. On your death, the income may continue to be paidfor the rest of the guarantee period, or it may be paid to your estate (andinheritance tax might be due on it).Ask for quotes for five and ten yearguarantees.

If anyone is financially dependent on you, do not look on a guaranteeperiod as a substitute for a joint-lifeannuity. If you live to the end of theguarantee period, the survivor will getnothing after you die. If you choose ajoint-life annuity, a guarantee periodmay be less useful.


Example of joint-lifeannuity

Jack is 65 and his wife Emma is 60.In December 2003, Jack retires. After taking a tax-free lump sum(see page 5), he has £62,000 in hispension fund with which to buy an annuity.

He opts for a joint-life RPI-linkedannuity with no guarantee (seepages 15 and 17) which provides:

■ a starting pension for Jack of£2,532 a year;

■ a pension for Emma if Jack diesbefore her. This will be one-thirdless than the amount paid whenJack was alive. Based on thestarting income, this would be£1,688 a year (2/3 x £2,532);

■ increases in line with inflationto ensure that both the originalpension and Emma’s widow’spension keep the same buyingpower throughout retirement.

All ‘extra’ annuity benefits cost money

by reducing the amountof your initial annuity

income.

Example of an annuitywith a guarantee period

Harriet, 60, retires. After taking atax-free lump sum (see page 5), she uses the remaining £30,000pension fund to buy an annuity. She hopes to live to a ripe old agebut, if not and having no closerrelatives, she would like to leavesomething to her nephew. Shechooses a single-life level annuitywith a ten-year guarantee.

Harriet gets an income of £1,788 ayear. Whatever happens the annuityguarantees to pay out 10 x £1,788= £17,880.

After only two years, Harriet dies. The annuity has paid her a totalincome of £3,576. The rest of theguaranteed annuity paymentscontinue to be paid to her estateand will be distributed according to her will.



The amount of any bonusesdepends on many factors, such as:

■ how well investments are doing –for example stock marketperformance; and

■ business risk – the financialstrength of the fund.

For more information on with-profits,see the list of FSA publications on page 39.

With a few annuities, a minimumbonus rate – for example, 3% a year –is guaranteed. Sometimes you canchoose the guaranteed rate, but thehigher the guarantee, the lower yourstarting income.

Usually, your starting income is basedon an ‘assumed (or anticipated) bonusrate’ (ABR). You choose the ABR at theoutset from a range set by the insurancecompany – for example 0% (whichassumes no bonuses at all) to 5%. Oncechosen, most insurance companies donot allow you to change the ABR.

The insurance company announcesnew bonus rates every year. If the rateequals your chosen ABR, your incomedoes not change. If the declared bonusis higher than the ABR, your incomeincreases. But if the bonus is lowerthan the ABR, your income falls.

If you choose a low ABR, your startingincome is low. But you increase thelikelihood that future bonuses willexceed the ABR and that your incomewill rise. You also reduce the risk thatyour income will fall. If you choose ahigher ABR, your starting income willbe higher.

If you choose the lowest ABR of 0% –in other words, assuming no bonusesat all – your starting income will bejust the minimum. As long as thecompany declares any bonus at all,your income will increase. In general,your income can’t fall, because thebonus rate can never be lower than0%. (However, if long-termstockmarket performance were verypoor, even this minimum startingincome could be cut, except in the caseof with-profits annuities thatguarantee the minimum.)

Your choice of ABR may depend onyour need for income. For example,suppose you intend to carry onworking for now. By choosing a low ABR, you can plan for a lowincome now, increasing by the timeyou fully retire.

Check annuity rates online at www.fsa.gov.uk/tables 2120 Check annuity rates online at www.fsa.gov.uk/tables

If the risk of an unpredictable, and possibly falling retirementincome worries you, stick toconventional annuities. You mightwish to take specialist financialadvice – see page 34.

Investment-linked annuities.

The chance of a higher income infuture – but only by taking extra risk.

Investment-linked annuities offer thechance of a higher income than you canget from level or increasing annuities(often called ‘conventional annuities’)that are linked to fixed-interest assetssuch as gilts – loans to the government – and bonds – loans to companies. But you need to be comfortable withlinking your income in retirement to theups and downs of the stockmarket.

Investment-linked annuities are more risky than conventional annuities because:

■ your income is likely to changeeach year, and could go down aswell as up;

■ the size of any increase isunpredictable.

Investment-linked annuities can either be:

■ ‘with-profits’ (see below); or

■ ‘unit-linked’ (see page 22).

With-profits annuities

How with-profits annuities work

These link your income directly to the performance of the insurancecompany’s with-profits fund.Typically, your income is made up of two parts:

■ a minimum starting income

This is set at a low level but, unlessinvestment conditions are very bad,you’ll usually get at least this muchincome. Some with-profits annuitiesguarantee it;

■ bonuses

The insurance company usuallyannounces bonus rates once a year.Bonuses can be both ‘reversionary’(guaranteed to pay out for theduration of your annuity) and‘special’ – these only pay out for a year or so until the next bonus announcement.


www.fsa.gov.uk/tablesCheck annuity rates online at www.fsa.gov.uk/tables 23

The more risky the underlying fundyou choose, the more your retirementincome may vary – both up and down.

Some unit-linked annuities work in asimilar way to with-profits annuities.Your starting income is based on anassumed growth rate (this works likethe assumed bonus rate explained onpage 21). If the fund grows at thatassumed rate, your income stays thesame. If growth exceeds the assumedrate, your income increases. If growthis less than the assumed rate, yourincome falls. A few unit-linkedannuities let you invest in a‘protected fund’ which limitsthe fall in your income.

Most unit-linked annuities do notguarantee any minimum income. Evenif your income is based on an assumedgrowth rate (see above) of 0%, yourincome could still fall if the value ofthe underlying investment fund falls.

You should not consider a unit-linkedannuity unless you can cope with anincome that may swing widely andmay fall. You would need a largepension fund or other sources ofincome (or both) to fall back on.

If you are not comfortable withfluctuations in your retirementincome, check the alternatives usingthe chart on pages 24 and 25.

22 Check annuity rates online at www.fsa.gov.uk/tables

Unit-linked annuities are higherrisk than either conventional orwith-profits annuities.

Example of with-profits annuity

Chris is 60 and about to retire. He uses his £100,000 pension fundto buy a with-profits annuity. Thestarting income depends on theABR (see page 21) that Chrischooses. His options are:

■ the lowest ABR of 0% – Chris’starting income would be £4,600a year. But, provided the insurancecompany announces any bonusat all, his income would normallyincrease each year.

■ the highest ABR of 5% – Chris’starting income would be muchhigher at £7,800 a year. But hisincome would increase in futureyears only if the actual bonuseswere more than 5%. Every timethe insurer announced a bonusof less than 5%, his incomewould fall.

■ an ABR between 0 and 5% – This gives a starting income ofmore than £4,600 but less than£7,800 a year.

Ask the insurance company toprovide examples to show how yourincome can go up or down eachyear, depending on the actualbonuses announced.

How unit-linked annuities work

Your income in retirement will belinked directly to the value of anunderlying fund of investments.Generally, you can choose the types of fund, for example:

■ medium-risk managed fund where afund manager selects a broad rangeof different shares and otherinvestments – spreading yourmoney widely reduces risk;

■ higher-risk fund where a fundmanager selects shares and otherinvestments in a particular country– Japan, say – or sector, such assmaller companies. Because yourmoney is less widely spread, the riskis higher;

■ tracker fund (usually medium risk)which tracks the performance of aparticular stockmarket index.Usually, these have lower chargesthan managed funds.

Unit-linked annuities


www.fsa.gov.uk/tablesCheck annuity rates online at www.fsa.gov.uk/tables 25Check annuity rates online at www.fsa.gov.uk/tables24

Consider:

■ a with-profits annuity with a 0% ABR – see page 20; or■ phased retirement – see page 26.

StartDo you have a wife, husband, or other partner?

Will this annuity be a major source of your retirement income?

Do you have a pension fund of morethan £100,000 to buy this annuity?

Would you be comfortable with anincome that could fall as well as rise?

Whatever other annuity options you choose, you shouldnormally consider a joint-life annuity – see page 17. Now follow the arrow to check the other options.

You could consider a level annuity (see page 14) but beaware that, because of inflation, it will buy less and less as time goes on. To guard against this, follow the arrow to check out alternative annuities.

Consider:

■ a fixed-rate increasing annuity (which increases by a fixed amount each year) – see page 15; or

■ an RPI-linked annuity (which normally increases in line with inflation) – see page 15.

No

Yes

Yes

No

No

No

Yes

Yes

If you would like your annuity to be guaranteed for a specificnumber of years so that it will continue to pay the income(usually to your partner or estate) if you die before the timeperiod is up, choose a guaranteed annuity – see page 18.

Use this chart to help you choose a suitable annuity.

Consider: ■ a with-profits annuity (see page 20); or■ a with-profits annuity with a higher ABR (see page 20); or■ a unit-linked annuity (see page 22); or■ income withdrawal (see page 28).


Retiring gradually

Most personal pensions can bearranged as a single plan, or as acluster of many separate plans,sometimes called ‘segments’. The segments can then be used to buy annuities at different times. All the segments must be used to buyannuities by the time you reach the age of 75. This process is called‘phased retirement’.

Each time you convert a segment to an annuity, you can first take part ofthe segment’s fund as tax-free cash (see page 5). Converting segmentsregularly – for example, once a year – means you can effectively use thetax-free cash, as well as the annuity, to provide your income. Thedrawback is that if you stagger theconversion of segments into annuities,you will not be able to take all yourtax-free cash from your total pensionfund at once as a single lump sum.

You must convert enough segmentseach time to buy an annuity. Insurance companies often set aminimum purchase price.


‘Phased retirement’ uses annuities to provide a flexible income.

Phased retirement is complicatedand requires thought, planning andmanagement. You’ll probably needsome specialist financial advice –see page 34.

Phased retirement can be a very usefulfinancial planning tool, for example, if you want to ease back gradually onwork and start to replace yourearnings with pension income.

It also provides more flexible help foryour survivors if you die. Segmentsthat have not yet been converted toannuities can provide a pension foryour surviving dependants or a lumpsum, depending on the terms of thepension plan.

By taking an income in this way you are reducing your pension fundand relying on investment growth to replace part or all of what you have taken.

Phased retirement is generallysuitable only if you have a fairlylarge pension fund, or have otherassets or income to live on. This isbecause the bulk of your pensionsavings remain invested – usuallyin the stockmarket – which may bemore risky than buying an annuitystraight away.

Income withdrawal involves extracosts and extra investment riskcompared with buying an annuitystraight away. For this reason, it isusually suitable only if you have apension fund of over £100,000(after taking any lump sum) or youhave other assets and sources ofincome to fall back on.


Income withdrawal


You do not have to buy an annuitystraight away when you want to start taking an income from yourpension fund.

Instead, you can put off buying theannuity until as late as age 75, thoughit is a good idea to review this decisionregularly. In the meantime, you cantake an income direct from yourpension fund – this is called ‘incomewithdrawal’ or ‘income drawdown’.

If you want to take part of yourpension fund as a tax-free lump sum(see page 5), you do this beforestarting to take income from the fund.The income you take out of yourremaining pension fund is taxable.

Income withdrawal is an option withsome personal pensions and somemoney purchase employer’s schemes.But sometimes, if you are in anemployer’s scheme and want to useincome withdrawal, you must first

transfer your pension rights from theemployer’s scheme to a personalpension. There will probably becharges for making this transfer.

Because the bulk of your savings remaininvested in the stockmarket, the valueof your pension fund can go down aswell as up. Provided you understandthese risks and feel comfortable withthem, there are several reasons forconsidering income withdrawal:

An alternative to buying an annuity – until age 75 at the latest.

■ you want the flexibility to vary theamount of pension income youtake. Maybe you need the cashlump sum but have little immediateneed for income. Or perhaps youare retiring gradually and need aflexible and increasing income;

■ you want to leave your heirs thebulk of your pension fund (thougha tax charge would be deducted) ifyou died before reaching age 75;

■ you are confident that your pensionfund can be invested for a betterreturn than you would have gotfrom an annuity. This almostcertainly means investing in share-based investments and you mustfeel comfortable with thestockmarket risk;

■ you want to avoid being locked intocurrent annuity rates and want towait until they rise. But bear in mindthat future annuity rates could fall.

The Inland Revenue limits themaximum income that people can takeout of their pension fund throughincome withdrawal. The maximum isbroadly the same as a level annuity fora single person of your age and sex.Like annuity rates, this maximumoften changes. Current InlandRevenue rules also require you to takeat least a minimum income – which isset at 35% of the maximum.

The company that you invest withmust review your income withdrawalarrangement every three years. This isto make sure that your income staysbetween the Inland Revenue’sminimum and maximum limits. Thismeans you may have to take a cut inincome if you had been drawing themaximum or an increased income ifyou had been drawing the minimum.

Think about reviewing yourincome every year as well as thedecision on when to make the finalannuity purchase.

Example ofincome withdrawal

Dan retires at age 55. He will have£250,000 in his pension fund aftertaking a tax-free lump sum (seepage 5). Since annuity rates arerelatively low for someone as youngas Dan, he is interested in incomewithdrawal. His financial adviserworks out the current limits on theincome Dan can take. The maximumis £17,500 a year and the minimumis £6,125. These limits will applyfor three years, after which theywill be recalculated and willprobably change.


Income withdrawal is complicated and risky, so get advice – see page 34.

Where to buy annuities

As with most things, shopping around can get you a better deal.Although you can usually buy anannuity from the same company withwhich you built up your pension fund,do not assume it will automaticallyoffer you the best rate. You may dobetter by shopping around andchecking if another company couldoffer you more.

In most cases, you can use yourpension fund to buy an annuity fromanother company. This is called usingyour ‘open market option’. Yourinsurance company must tell youabout this and explain the advantagesand disadvantages. Make sure you askfor all the information you need toshop around for the best deal.

Before shopping around, make sure you understand what your provider is offering you.

Does the company holding yourpension fund offer you a guaranteedannuity rate? (In the past, someinsurance companies sold these sortsof plans. Now that annuity rates are alot lower, these guarantees can be veryvaluable, but might not apply to thetype of annuity you need.)

Other points to consider:

■ Will your existing company imposea penalty charge if you buy yourannuity from another company?

■ Does your fund need to be a specific size to qualify for the betterrates offered by another company? You may find it difficult to shoparound if you have a small pensionfund (say less than £5,000). Some firms may not be interested inadvising on small sums, or mighthave high charges for this service.

Annuities are sold by insurance companies – shop around for the best deal.

If you opt for a high withdrawal rateand investment returns are poor,income withdrawal may run downyour pension fund too quickly. There is a danger of running it downso far that, when you eventually haveto buy an annuity, you can afford onlya very small income for yourremaining retirement.

For more detailed information, see the FSA Factsheet Income withdrawal– a retirement option for you?

Phased retirement (see page 26) andincome withdrawal can be combined

This means you would start to drawan income from just part of yourpension fund on one date, leaving therest of the fund intact. To increaseyour income at a later date, you couldeither increase the rate of withdrawal(provided you did not exceed themaximum limit) or start to draw anincome from a further slice of yourpension fund. This option is veryflexible, but complicated. Getprofessional advice – see page 34.

There can be a big difference betweenthe best and the worst annuity rates.

You may be worse off in retirementthan you need to be if you don’t shoparound for the best annuity – seeexample opposite.

■ Do you have a medical conditionthat could reduce your lifeexpectancy? – see page 11. Some providers of impaired lifeannuities are interested in pensionfunds smaller than £5,000.

Some companies are keen to attractannuity customers, so they offercompetitive rates; others are less keen.The company you choose can affectyour income by hundreds of pounds ayear. When comparing differentquotes, make sure they are based onidentical benefits as there are manydifferent options to choose from.

Annuity rates are available on theFSA’s Comparative tables website at www.fsa.gov.uk/tables

Useful contacts, page 37, lists some ofthe other sources you can use to findout about different companies’annuities. Alternatively, get specialistfinancial advice – see page 34.


Example of how the openmarket option can getyou a better rate

Jerry, aged 65, has a pension fundof £22,000 left after taking a tax-free lump sum. He is single anduses the fund to buy an escalatingannuity that will increase by 3%each year.

The company with whom he builtup his pension offers him anannuity rate of £453 a year for each£10,000 (4.5%). This would givehim a pension of £996 in thestarting year (£22,000/£10,000x £453).

Jerry finds the best rate he can getfrom another company is £556 foreach £10,000. This would provide astarting pension of £1,223 a year(£22,000/£10,000 x £556).

By shopping around, Jerry hasincreased his pension by £227 inthe first year and even more insubsequent years.

More than one pension fund?

If you are using more than one pensionfund to buy an annuity, think aboutcombining them when you areshopping around – larger funds mayattract better rates.

Advantages of combining your funds:

■ Many of the best-rate annuitieshave a minimum purchase price.

■ Smaller pensions may be paid lessoften than monthly.

■ It’s often easier to budget with justone payment a month.

Possible drawback:

■ The risk of having all your eggs inone basket (especially if you choosean investment-linked annuity andyour provider turns out to be arelatively poor performer).

Five steps to shopping around for your annuity

This is only feasible if done around sixweeks before your retirement date.

1. Get an estimate of the value of your pension fund, taking accountof any charges, from your pensionprovider.

2. Decide how much tax-free lumpsum you want to take and deduct it from the value given.

3. Decide on whether you want:■ a single or joint-life annuity;

if joint life, whether the pensionto your partner is paid in full orreduced (say by one third);

■ a level or increasing annuity; if increasing – then by RPI or a fixed rate.

4. Think about whether you might be eligible for an impaired-life or an enhanced annuity. If you think you are, then discuss it with theannuity provider.

5. Think about whether you want anannuity to continue being paid toyour partner or estate, for a specificnumber of years (5 or 10) if youshould die shortly after retiring.

Now armed with all these facts, you can get quotes from a range of providers. Remember thatannuity quotes are fixed forbetween 7 and 28 days.

Once you decide to accept anannuity quote, you will have a 14-day ‘cooling off’ period inwhich to cancel, if you change your mind.


Where to get advice


Annuities and income withdrawalarrangements are offered by insurancecompanies. You can get advice about aparticular company’s products directfrom that company or its representatives.

Alternatively, contact an independentfinancial adviser (IFA) who can adviseon all aspects of annuities or incomewithdrawal, including which companywill best meet your needs.

Financial advisers, whether they areindependent or work for a singlecompany, must be authorised to giveinvestment advice. Authorisationprotects you. For example, authorisedfirms have to meet regulatorystandards. And, if an authorised firmgives you the wrong advice for yourcircumstances, you will have accessto a proper complaints systemand redress.

Both company representatives andindependent advisers must askquestions about your personal andfinancial circumstances, so they cangive you suitable advice tailored toyour circumstances.

A few IFAs specialise in giving adviceonly about annuities or incomewithdrawal – this is sometimes clearfrom their names, which often includethe word ‘Annuity’ – see Usefulcontacts on page 37 for how to find an adviser.

Annuities are complicated, so think aboutgetting some professional advice.

Check that your adviser is authorised

by checking on the website or call

the FSA Consumer Helpline – see

Useful contacts on page 37.

How do you pay for financial advice?

Insurance company advisers are paidby salary, bonus, or a mix of the two.Other advisers are paid throughcommission. For annuities, the adviseris usually paid by commission. This ispaid by the insurance company, soshould not affect the amount you payfor the annuity. But ask if you have topay the adviser any additional charges.

Information you’ll get

With annuities, you get an illustrationshowing the amount of pension youwould get, given the size of yourpension fund, your personal detailsand current annuity rates. The figuresare shown after deducting any sumyou have chosen to take as tax-freecash. The illustration also shows howmuch your adviser will be paid if youtake up the annuity.

You will also get a Key Featuresdocument describing the main aspects of the annuity, such as charges and the risks.

Make sure you read and understandthe information in the Key Features.

In the case of a with-profits or unit-linked annuity, the illustration willinclude examples of how your annuityincome might vary in future years.These projections will be based onstandard assumptions about thegrowth of the underlying investmentfund – the fund will not necessarilygrow at these rates.

If you choose a with-profits annuity,you should ask about the company’sapproach to setting bonus rates.

If you are considering incomewithdrawal, the illustration mayinclude ‘critical yield’ figures. They show:

■ how much your pension fundneeds to grow to let you withdrawan income equal to what youwould have got if you’d bought anannuity straight away;

■ how much your pension fund needsto grow to maintain indefinitely thelevel of income you have chosen.

For more information, see the FSA guide to financial advice. Call the FSA Consumer Helpline for your free copy or order or download a copy from our website – see Useful contacts on page 37.


Complaints

■ Employers’ scheme pensions

If you have a problem concerning apension from an employer’s scheme,first contact the pensionsadministrator at work.

Your employer’s scheme must by lawoffer a formal complaints procedure.If this cannot settle the matter, contactthe Pensions Advisory Service (OPAS).It will attempt to mediate between youand the scheme and, if necessary, willhelp you take your case to thePensions Ombudsman – see Usefulcontacts on page 37.

■ Personal and stakeholder pensions

If your complaint is about the adviceyou received or the marketing orselling of the pension, then first takeup any complaint with your adviser or the personal pension company.Take the case to senior managementlevel if necessary. If the dispute is still

unresolved, contact the FinancialOmbudsman Service – see Usefulcontacts on page 37.

If your complaint is about the wayyour pension is run, contact thePensions Advisory Service (OPAS) –see above.

For more information, call the FSAConsumer Helpline on 0845 606 1234for your free copy of the FSA guide tomaking a complaint. This booklettakes you step by step through theprocess of making a complaint andgetting matters put right.


There are procedures to help you if things go wrong.

Useful contacts

For details of pensions fromemployers’ schemes

The pensions administrator, pensionsmanager or pension scheme trustees.You usually get in touch via theHuman Resources or PersonnelDepartment.

To trace pensions you’ve lost track of

The Pension Schemes Registry (atOpra – the Occupational PensionsRegulatory Authority)tel: 0191 225 6316website – www.opra.gov.uk

To find out about your entitlement to the state pension

The Retirement Pension Forecast TeamTo get an estimate of how much stateretirement pension you can expect.tel: 0845 300 0168website – https://secure.dss.gov.uk/br19

To check the tax aspects of pensions

Your local tax office (look in thephone book under ‘Inland Revenue’)website – www.inlandrevenue.gov.uk

To check current annuity rates

FSA Compatative tables websitewww.fsa.gov.uk/tables

CeefaxPage 260.

MoneyfactsSpecialist magazines, such asInvestment Life & PensionsMoneyfacts – try your local public reference library.Moneyfacts faxback service (updated daily) – fax: 090 60760731(calls currently charged at a maximum of 75p a minute).

Personal finance pages of nationalnewspapers and personal financemagazines, such as MoneyManagement and Planned Savings,available from newsagents and insome reference libraries.


Organisations that can help you findan independent financial adviser (IFA)

Association of Independent FinancialAdvisers (AIFA)Austin Friars House2-6 Austin FriarsLondon EC2N 2HDtel: 020 7628 1287 website – www.aifa.net

IFA Promotion0800 085 3250website – www.unbiased.co.uk

Society of Financial Advisers (SOFA)tel: 020 7417 4442(only for names and addresses of advisers)website – www.sofa.org(provides full contact details of advisers)

Matrix-Data Directorywww.ukifadirectory.co.uk

Occupational pension scheme disputes

The Pensions Advisory Service (OPAS) Pensions Helpline: 0845 601 2923website – www.opas.org.uk

The Pensions Ombudsman tel: 020 7834 9144website – www.pensions-ombudsman.org.uk

Personal pension disputes aboutmarketing or selling

Financial Ombudsman ServiceSouth Quay Plaza183 Marsh WallLondon E14 9SRtel: 0845 080 1800website – www.financial-ombudsman.org.uk

To help you find the right organisationand for copies of our free booklets

FSA Consumer websitewww.fsa.gov.uk/consumer

To check that an adviser is authorisedgo to www.fsa.gov.uk/consumer and follow the link to the Firm andPerson Check.

FSA Consumer Helplinetel: 0845 606 1234 (calls charged at local rates)


Asking the right questionsOther FSA publications that could help you - December 2003

FSA guide to saving for retirement –starting to save

FSA guide to saving for retirement –reviewing your plans

FSA guide to topping up youroccupational pension

FSA guide to the risks of occupationalpension transfers

FSA guide to the risks of opting out ofyour employer’s pension scheme

Contracting-out of the State Second pension

Stakeholder pensions and decision trees

AVCs, FSAVCs and stakeholderpensions – joining or rejoining youremployer’s AVC scheme

Retiring soon – what you need to do

Your pension – it’s time to choose

Income withdrawal – a retirementoption for you?

With-profits policies


We produce a range of user-friendly factsheetsand booklets which are available from ourwebsite and helpline.

If after reading this factsheet, you have anygeneral queries, our helpline will try to clarifythings for you.

We can tell you if a firm or individual isauthorised and help you if you have acomplaint and don’t know who to contact. But as the regulator, we can’t recommendfirms or advisers, or tell you whether aparticular investment is right for you.

Check annuity rates online at www.fsa.gov.uk/tables

Authority (FSA) is the FSA guide to annuities and income withdrawalwebarchive.nationalarchives.gov.uk/20060213205517/fsa... · · 2005-03-13FSA guide to annuities and income withdrawal

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