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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
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:
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by Michelle McGagh on Mar 11, 2014 at 14:49