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How to buy an annuity

The financial regulator has turned its attention to the annuity market amid concerns that pension savers aren't looking for the best deal.

 

by Michelle McGagh on Feb 05, 2013 at 14:09

How to buy an annuity

The City watchdog has launched a probe into the way annuities are sold to make sure people know how to get a good deal with their pension savings when they come to retire.

Annuities are life insurance contracts that retirees buy with their pension savings. There are different types of annuities but put simply they pay out a monthly income until you die. They are in effect your pension.

The amount of income you get depends on the level of long-term interest rates, the size of your pension pot and how long the insurance company thinks you are likely to live. The longer your life expectancy, the lower the rate.

In the past decade annuity rates have plunged as interest rates have fallen and people have lived longer. This is why the Financial Services Authority thinks it is important to encourage people to look around for the best annuity their money can buy. Far too many people still just buy an annuity from the insurance company with which they have saved their pension and get an unnecessarily poor rate on their money.

What does the regulator want to know about annuities?

The Financial Services Authority (FSA) has launched a probe into the annuity market, which is worth around £11 billion a year.

Its investigation will be split into two parts; the first phase will assess the level of detriment that consumers suffer if they do not shop around for their annuity. Buying an annuity from a company that does not provide your pension is known as exercising your 'open market option' (OMO) and the FSA is interested to know how much pension income you lose out on if you do not look for the best annuity rate but just opt to buy your annuity from your pension provider.

The second part will focus on whether annuity providers are helping or discouraging consumers from comparing annuity deals and allowing them to buy an annuity from whichever provider they chose.

The FSA will look at how annuity providers price their annuities and compare the rates available to consumers who are existing customers to those who are new customers, or exercising OMO.

The investigation into annuities is running alongside a new code of conduct implemented by life company trade body, the Association of British Insurers (ABI), which will set out a range of annuity rates on its website among other changes.

Nick Poyntz-Wright, FSA head of life insurance, said the new regulator which comes into force later this year – the Financial Conduct Authority (FCA) – will ‘make sure markets work well so consumers get a fair deal’.

‘An annuity purchase is an important one-off decision that has long-term consequences for individuals if they get it wrong,’ he said.

‘We want to understand the level of the potential detriment for consumers if they do not shop around to see if there are ways to make this market work better for consumers.’

The FSA said the first phase of the investigation will run until the second half of the year and the second half will depend on the outcome of the first.

I don’t have to buy an annuity from my pension provider?

You definitely do not have to accept the annuity offered to you by your pension provider. Just because you have saved over the years with a particular company does not mean you have to accept their annuity rate. This is a common problem as pension providers have not promoted the OMO.

But this does not mean you shouldn’t see what your pension provider has to offer. Check whether the provider offers a guaranteed annuity rate for people who save with it – often guaranteed annuity rates are very generous, especially when compared with the generally poor rates on offer at the moment.

If you do want to move your money to another company, check with your pension provider just how much you will be charged for doing so.

What exactly is the open market option (OMO)?

The OMO gives you the option to transfer your pension fund to another provider. This gives you the right to shop around for the best annuity rate.

Although it was introduced in 1975 Finance Act, people are still unaware of their right to exercise the OMO, and only a third of people coming up to retirement do so. The ABI is concerned about the lack of awareness of OMO, and has developed a code of conduct that will flag OMO and the benefits of shopping around, and provide illustrations showing how much more money you can receive because of your health or lifestyle. Now the FSA has jumped on the bandwagon, which is why it has launched a thematic review.

How do I shop around?

Shopping around for the best annuity rate is a no-brainer, but with so much information out there it’s hard to know where to start or what information you need to compare.

One of the best ways to shop around is by employing the services of an independent financial adviser (IFA). An IFA is not tied to any particular company, so instead of trying to flog you a particular product they are working for you to get you the most income in retirement and find an annuity that is most suitable for your needs. There are advisers that specialise in annuity purchases.

Help is also available online from the Money Advice Service, a free, government-run website. This site has a comparison table of annuity rates that is updated regularly and will help you to understand how much income you will receive from different insurers.

The site is currently adding more providers, including Prudential, Standard Life and MGM Advantage, and should be updated in a few weeks. There's also a plethora of annuity comparison websites that a quick Google will unearth.

Is it just the annuity rate I need to look at?

No, you also need to look at the type of annuity you are buying. Of course, everyone wants to maximise their income, but you have to consider what else you want from the annuity.

Tax-free cash: Everyone reaching retirement is entitled to take 25% of their pension fund tax free. If you plan to do this it will reduce the amount of money you have to turn into a monthly income, so you have to make sure you put that into your comparison.

Remember that although 25% is the maximum you can take, you can take anything from 0% to 25%, although a lot of insurers don’t make this clear. Unfortunately, most online comparison sites assume you want to take all the tax-free cash, so it is worth talking to an IFA if you want to take less than 25%.

Spousal benefit: If you have a spouse then you may need a ‘spousal benefit’, where your husband or wife is provided with a pension from your pot when you die. Without a spousal benefit the annuity will no longer pay out, even if your other half does not have a pension of their own.

Adding a spousal benefit on to your annuity costs money and will reduce the amount of income you receive. If your spouse has a pension of their own it may not be necessary to add a spousal benefit.

Enhanced annuities: You could be entitled to a lot more pension income if you have an existing health problem or if your lifestyle damages your health. Insurers offer more income to people who have medical conditions, smoke or lead unhealthy lifestyles because they believe they will die sooner and won’t need to pay out the income for as long.

It is thought that half of retirees could get more money from an annuity in this way, but currently only 17% of people coming up to retirement actually purchase an enhanced annuity.

Annuities are complex, and you only get one shot at purchasing one. You need to make sure you not only get the most amount of income for your money but that the annuity you take out serves your needs properly.

If you are unsure about any aspect of the annuity purchase process you should contact an IFA who will be able to help you achieve the best outcome.

For more information read these other annuity guides from The Lolly:

26 comments so far. Why not have your say?

Clive THOMPSON

Jul 24, 2012 at 15:04

Shopping around for your annuity cannot be emphasised enough but with the caveat that you use your current provider as the benchmark for what you do next. Some older style pension policies offer guaranteed annuity rates that were about average when the policy started but are now significantly higher than the rates currently available.

Given the myriad of options to choose from and that you get one chance at buying an annuity, having someone talk you through these options whilst objectively looking at your personal and financial circumstances must be worthwhile. An IFA specialising in retirement income options will work for you and not simply "flog" a product.

Your health and other lifestyle factors should always be considered as they can influence the rate you receive. In a recent case, a client of mine received 23.5% more income per annum essentially because of the spouses medical history. Of the eight providers invited to quote for the annuity only four agreed to an enhance rate so it pays to shop around.

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A Sick SIPP Owner

Jul 29, 2012 at 15:26

Yes - and don't forget to take up drinking and smoking for the last year before you get the annuity.

Then again - remember that if the 'company' you buy the annuity goes bust - wave goodbye to the income!

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James via mobile

Jul 29, 2012 at 16:24

Thank you to arminvestors.com for providing two pieces of useless and incorrect information.

Taking up smoking and drinking a year before retirement will make no difference whatsoever, you need to have smoked and drank excessively for many years to make a difference.

With regards to the annuity provider going bust, this would be coverede by the FSCS and the majority of the income would continue.

I would rather take advice from a good IFA than this numpty!

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A Sick SIPP Owner

Jul 29, 2012 at 17:04

Well - - -

Consider the 'fate/state of the ARM SA investment fund - as reccomended by IFA's

Consider

http://www.telegraph.co.uk/finance/personalfinance/pensions/8532324/Annuities-when-pounds-add-up-to-s.html

Consider

The FSCS limits it's recompense (assuming you do qualify) to up-to £50,000

So -

James, where did you buy your qualifications? and what are they?

I 'bought' mine following advice and discussions with an IFA, and then the regulators appear to have done a good job of wrecking the investment fund, but maybe not as good a job as the government and EU have done on UK pension annuities.

If I had gone for an annuity 15 years ago I'd probably still be getting more than the current annuities offer for a 65 year old man, and collected 15 years 'pension' from it.

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James via mobile

Jul 29, 2012 at 17:24

Armchair. Thank you for asking about qualifications, I am a Chartered Financial Planner so better qualified than most to comment on this.

With regards to your previous investments, I am sorry that you have had a bad experience and accept this could be as a result of your own decisions or as a result of bad advice. I see evidence of both far too often.

The point I was trying to make is that there is a lot of misinformation available and comments such as yours that have no factual basis are not helpful.

The £50k limit you mention has no bearing whatsoever on annuity payments. What good do your comments make if somebody reads them and believes them to be true?

Also, governments haven't created low annuity rates. Low gilt yields and longevity have. Find a good IFA (there are lots of good ones if you know where to look) and get yourself some good quality and accurate information.

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A Sick SIPP Owner

Jul 29, 2012 at 18:17

James,

Presuming your comment to "armchair' was directed at me -

congratulations on your qualifications and the experience needed to get them.

Re my pension investment - the idea was to defer getting an annuity hoping the rates would improve.

I'm not sure that the advice I got was bad, however it has since become public knowledge that the FSA consider some of the actions of Rockingham and Catalyst to be inappropriate to the point where they 'issued' fines - pity is that they did not make their concerns public until late in 2011, concluding with the declaration that Death bonds are Toxic.

The fund ran foul of the regulator - it appears that 2 'issues' of £50M a year are OK, but 3 of £20M are not OK without 'authorisation'!

And requirements for 'authorisation' included a liquidity fund of about $60M - probably enough to pay costs on all ythe death bonds' for 8 years - longer than my investment was supposed to be for!.

Re the £50K limit not applying to annuities - I'll have to investigate that.

Re the government not 'creating' low annuity rates - The 'press' seem to indicate to me that the rates are effected by gilts - rates for which I understood are basically government influenced if not set, and QE which is - I understood basically government set - and I consider the BoE to be within the government.

Still - Hindsight is a great facility - and a good advisor can use that as a vehicle for foresight. I just wish the regulators had either left my pensoin fund alone, or not been so secretive in their actions to "Protect the Public" that the IFA's were not made aware until about a year later that the regulator considered there were problems with the reccomendation and sale of the ARM bonds.

Still - back to buying an annuity -

Still appropriate to make sure you declare any activities you do, or have done that may effect your expectation of death.

And considering that the FSCS may not be active, in the same way in 5 years - worth being careful about who you buy your annuity from.

A contract with a bankrupt, or liquidated organisation isn't worth a lot, and you definitely cannot rely on the government not changing the rules/regulations/laws etc. that effect pensions and annuities.

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Anonymous 1 needed this 'off the record'

Jul 30, 2012 at 09:38

Given that annuities are based on income rates, it is looking like a black hole.

Now although this might sound curious, why not purchase a French insurance pension rente, which enables capital retention, and, if modified, drawdowns. The previous labour wastrels at the Treasury will then see the French Treasury balance sheet increased, the euro supported, and the capital that was going to shore up the balance sheets of the current bunch of Anglo-american insurance wasters, retained for the benefit of the pensioners concerned.

All on the basis of the EU freedom of movement of capital.

What would be better would be to retire to France as part of the package, as these pension arrangements are only income taxed upon income, not on capital paid.There is a slight wealth tax charge, bit that is more than acceptable in these current times.

Sensible these French..... They keep their money available as a private matter, not as a potentially nationalisable asset.

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J G

Feb 05, 2013 at 15:53

Yes, It is very scaring that private pensions are potentially nationalisable, one reason why I'm not paying in. It's all funny money. The UK private pension system is in such disrepute - with good reason - that we need radical consumer focussed change. We need to stop big zombie insurers (Abbey Life and others) from leeching off missold historic contracts skimming 45% of total individual savings. Above all we need to ensure that people can pay into portable schemes like ISA's and use them as a vehicle for retirement. Policy holders should not be prisoners - they should be able bargain, negotiate and move to different providers at all times.

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Anonymous 2 needed this 'off the record'

Feb 05, 2013 at 16:36

I AM 66.1/2 AND DID NOT BUY AN ANNUITY WHEN I WAS 65 AS THE RATES WERE UNAPPEALING. I HAVE ABOUT £27K OF FUNDS HELD WITH BLACKROCK WHO DO NOT PROVIDE ANNUITIES. I WOULD LIKE TO DRAW 25% CASH AND INVEST IT MYSELF BUT DO NOT NEED THE INCOME FROM THE REMAINING £20K OR SO - I HAVE SUFFICIENT. DO I STILL HAVE TO FIND AN ANNUITY PROVIDER AND GO INTO FLEXIBLE DRAWDOWN EVEN THOUGH I DO NOT PLAN TO DRAW ANYTHING? - I BELIEVE THAT ANY FUNDS NOT DRAWNDOWN WOULD BE TAXED AT 55% IF I DIIED.

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Clive THOMPSON

Feb 05, 2013 at 17:40

@ Anonymous 2

You can use Capped Drawdown to access the tax free lump sum and set the initial income at £0. You don't need to use an annuity provider although some insurance companies offer both. The problem you might encounter is the minimum investment size as Drawdown is usually only viable for larger funds and some providers have a minimum amount they'll accept. They may also only deal with you via a financial adviser.

Although I have no personal experience, you could look at Hargreaves Lansdown. They offer a low cost SIPP which could work for you.

You are correct, if you die whilst in drawdown and the residual fund is not used by your spouse to provide an income (i.e. continue with drawdown or purchase an annuity), the tax recovery charge is 55% of the fund.

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NormaDear

Feb 05, 2013 at 19:28

Miichelle mcgagh repeats all the usual advice about annuities.

But she failed to state the most important bit.

When you have found your ideal annunity, ASK, WHAT IS THE FEE?

And if the representative at the other end (HARGREAVES AND LANSDOWN) says "There's NO actual cost to you". Don't believe a word.

HL snaffled 3% of my very hard earned pension pot for a referal that took them about five minutes to do.

That was over £1400, or about £6.50 a week for the rest of my life.

So beware those annunity compare sites, they are ain't doing it for nowt and they are not exactly falling over themselves to tell you what the cost is, (except to mention later that the fee was included in the small print on page 8 or 9 on one of the six documents we sent).

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Maverick

Feb 06, 2013 at 22:50

NormaDear - Did no-one ever tell you - "if you want something done, do it yourself"?

If I had bought an annuity with my pension "pot", I would have got a return of under 6% a year. I took a chance on being able to beat that by keeping the SIPP invested and drawing down pension. So far it's working. Despite taking the maximum drawdown, my fund is about 4% a year up. That 4% is then compounded next year, and the next, and so on.

Because I haven't handed my fund over to an insurer, I can pass 55% of it when I die to my daughters. Because you have paid your money to an insurer, it has gone for ever.

If a big annuity provider does go bust, do you really think the Financial Services Compensation Scheme will have enough funds to pay everybody's pension every month?

Be afraid. Be very afraid . . . .

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Anonymous 2 needed this 'off the record'

Feb 07, 2013 at 01:02

I DON'T THINK THAT YOU CAN PASS 55% OF IT TO YOUR DAUGHTERS. THE TAX RATE IS 55% LEAVING 45% TO GO TO YOUR DAUGHTERS I BELIEVE!

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NormaDear

Feb 07, 2013 at 08:45

Maverick, It was not financially viable to use drawdown with my little "pot" .

I did study all the annuity options open to me before I took the annuity.

My beef with H&L is that their rep told me that there were no charges and then stuffed me for 3% for a 'NO ADVICE' deal which took just a few minutes.

As to an annuity company going bust, the whole financial system is a house of straw. If there was another Northern Rock type panic situation and everyone decided they wanted their ISA's/ shares/ funds sold and cashed, companies like HL would soon go to the wall.

I suspect that we are not too far away from another dose of 15%+ inflation.

So 55% of your sipp, taxed or not, might just buy your daughter a loaf of bread in twenty years.

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john brace

Feb 07, 2013 at 09:31

Picking up on the 3% charges by HL - this concerns me as my children have SIPPs with them, and I always understood there wasn't a charge[, although I believe there is a modest charge by whichever annuity company you chose - we're told it shouldn't be more than 1%.] Obviously nobody works for nothing. how can anyone avoid these 3% charges?

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NormaDear

Feb 07, 2013 at 10:48

As a note of explanation, my SIPP was with HL.

Having decided what annuity I wanted, I checked on the HL Annuity comparison site.

That led to a phone call, which led to the annuity deal being done, (with "no charge to you"). Later, purely by accident I discovered the £1424 fee had been taken from my pension.

I have since learnt that you cannot approach an annuity provider directly and need to use a broker. Apparently fee's vary from the likes of Aviva who give a set fee to the broker, (£200 was mentioned) to a percentage usually of 1%.

I am sure that the fact that the Annuity provider Hargreaves and Lansdown paid them a 3% fee had no bearing on them suggesting this provider to me!!!!!!!!!!!!!!!!!!

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Clive THOMPSON

Feb 07, 2013 at 11:22

Surely, if you are told there is no fee and you end up being charged one, you've been misled? I would ask HL to explain and justify it.

You and your Financial adviser should agree the cost of advising you on and implementing an annuity (or another other investment product for that matter) before proceeding so there are no surprises. As a guide, the cost could range between 1% and 3% of the annuity purchase price depending on the amount and complexity of the work. Finding out you've paid 3% and you didn't get any advice seems very expensive to me.

Since 1st January 2013, commission has been abolished on investment products so the payment to the adviser will be the same whichever provider is recommended. It will be the amount you've agreed to. Many annuity providers particularly, the specialist providers will only deal with you via a Financial Adviser so that you receive appropriate advice. If you want to arrange your annuity yourself, it's unlikely you'll avoid a fee using an online annuity comparison site because they are in business to make a profit.

Check the fees first!

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NormaDear

Feb 07, 2013 at 11:54

Good point Clive

But If you specifically ask what the fee is

and the reply is

"there actually aren't any costs to you directly" (verbatim)

You tend to believe there are no costs

Despite me repeated pointing this out to HL they just stone-walled me, hence the bile.

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Clive THOMPSON

Feb 07, 2013 at 12:47

@ NormaDear

I agree, why would you question it.

The clue is in the wording though as I suspect "directly" means your pocket and not necessarily your fund. The only way this can happen is by you authorising the recommended provider to deduct the fee from your fund. It would have been part of the application and it would have been disclosed in the personal illustration. The problem was you were expected the figure this out yourself!

If you enter into an agreement on the basis of there being no fee and then they surreptitiously take one, they've misled you and they should be held to account. HL have a complaints process.

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john brace

Feb 07, 2013 at 14:00

So, having checked the best annuity rate with, say, HL, is it then best to go directly to the Inuyrance co and pay their hopefully lower fee?

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dd

Feb 07, 2013 at 14:35

That's the problem. It may not be any lower. I haven't reached that stage yet but I would guess that it is worth getting several quotes, as with a plumber.

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Clive THOMPSON

Feb 07, 2013 at 15:35

Insurance companies do not charge you to set up an annuity, their costs are reflected in the annuity rate you receive and you cannot avoid them.

You would only pay a financial adviser a fee to advise you on your options, research the best annuity and set it up for you. If you don't want this service and you are prepared to do your own research a good place to start is the Money Advice Service. It' offer impartial guidance and an annuity comparison tool:

https://www.moneyadviceservice.org.uk/en/articles/how-to-shop-around-for-an-annuity

If, on the other hand, you would like the help of a specialist financial adviser, you should visit http://www.unbiased.co.uk/ and search for one in your area. Having shortlisted a few advisers, there's no harm in "googling" them to find out a bit more and by all means, check them out in person BEFORE committing.

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john brace

Feb 07, 2013 at 18:45

Clive - thanks for the explanation

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Pat

Feb 07, 2013 at 19:40

I still got two very small pensions, each valued at around £2,500. One is with Fidelity who recommended at one time an annuity of £42 per annum.

As £2,500 is above the threshold of rule of triviality, cash withdrawal is out of the question.

Can anyone give free advice as what I should do with these two £2,500.

.

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Clive THOMPSON

Feb 07, 2013 at 20:57

@ Pat

If you're aged 60 or more and your combined pension funds excluding the state pension are less than £18,000 you could take the fund as a lump sum as a trivial payment. There are conditions you need to meet so check them at the Money Advice Service:

https://www.moneyadviceservice.org.uk/en/articles/your-pension-lump-sum-options

If you don't qualify for a trivial payment, your options are limited because most annuity providers have a minimum purchase price of £10,000 so you would either accept the rates offered by your current providers or, if you can, top up the combined fund to make it £10,000 and then you'll have the choice of a number of annuity providers

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Anonymous 3 needed this 'off the record'

Feb 07, 2013 at 21:13

First thing I'd look at, is the cash-back as a trivial amount - but you've done that

Then - is a way to combine the 2 into a single fund, and reduce management charges, and fees for conversion.

OR

Wait until the 'trivial' limit rises to above the fund

OR

look for an investment that will reduce the value of the fund to below the current trivial limit

Yes - you will probably get the most advantageous-to-you result if you can lose 25% of the value of the funds

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