Know Your Options

May 3rd, 2008

Are you aged at least 50 and looking to start receiving an income from your pension plan(s) shortly?  If so, you will be facing a number of important decisions.  Whether you are looking to supplement your current income, or retire completely the decisions you make now can potentially affect the level of income you will receive for the rest of your life.

It is likely that you will be able to take a tax-free lump sum from your fund as well as receiving an income and this is usually up to a maximum of 25% of the fund value.  It is possible that you could be eligible for more than this if your pension plan started before the change in pension rules on 6th April 2006.  If you choose to take this lump sum, it must be taken at the start and can either be spent, or re-invested to provide additional income.  The options available with regard to your tax-free lump sum should be discussed with your financial adviser with the aim of ensuring that the right decision is made based on your circumstances.

The options for receiving an income are divided between receiving either a secured income or an unsecured income.  This article considers annuity purchase, which is the usual secured income route.

If you are purchasing an annuity, a number of important decisions need to be made before it starts. For example:

  • Do you want payments to be level, or increase each year, so that there is some protection against inflation?
  • Do you want to include provision for your spouse by selecting a joint life annuity, so that the income will continue to be paid if you were to pre-decease them?
  • Would you want to include a guarantee period ensuring the income is guaranteed to be paid for a minimum period, even if you die shortly after buying your annuity?
  • Is a ‘capital protected’ annuity appropriate, so that a lump sum can be paid in the event of death before age 75?
  • How often do you need to receive your annuity income – would you require a payment every month, or once a year?

These are important decisions that require very careful consideration because once they have been made and the annuity has started, they cannot be changed.

Another very important option to consider and one which is overlooked by a surprisingly high number of people, is the ability to take advantage of the Open Market Option.

The Open Market Option means that you are free to buy your pension annuity from any annuity provider on the open market, and not simply take the income offered to you by the provider holding your pension funds. Given that the most competitive annuity provider can pay up to 18% more income each year than the least competitive provider, then it obviously makes a lot of sense to shop around for the best deal you can get. (Source: FSA comparative tables 13/02/08 based on male 65 purchasing a joint life annuity with a fund of £100,000, on a 50% spouse, increasing by RPI basis).  After all, what is the point in spending many years paying into a pension plan and monitoring your investments within the pension fund if, when you come to finally take your benefits, you don’t then find out which provider will pay you  the highest income possible from the funds you have accumulated?
Furthermore, if you are a smoker, in poor health or have a certain medical condition, you may qualify for a higher annuity rate because of your shorter life expectancy. Examples of medical conditions that should qualify include heart disease, diabetes, high blood pressure, chronic asthma and bronchitis.
For more serious conditions it is likely that the provider will need to obtain detailed medical evidence by writing to your GP. This means the process will take a little longer, but will enable the annuity provider to offer the best possible terms.

Before researching the market, it is important to first find out if any of your plans contain guaranteed annuity rates (GARS) or preferential ‘in-house’ rates. These are only likely to apply under older plans that commenced before the early 1990’s, but if they do then there is a very good chance that these will be far better than the rates available on the open market. However, if there are no GARS or preferential in-house rates, you should then research the market to get the best deal you can.
When exercising your right to the open market option, it should be remembered that it is normal practice for your current scheme(s) to pay you your tax free cash and the residual fund value (the ‘purchase price’) is then transferred to the chosen provider who will pay you your annuity.
Choosing the right type of annuity as-well as getting the best deal available on the open market is a ‘once-only’ decision that you will not want to get wrong, so it is for this reason that we would recommend you speak to your financial adviser based on your particular circumstances and needs.

The value of investments and income from them can fall as well as rise.