Baffled and confused by pension jargon?
- Written by Daniel McGonigle
Pensions are a hot topic at the moment, mainly due to the increases most countries in the western world are making to their national pension age. There is so much technical jargon connected to pensions, most people are left baffled and confused. One major decision you have to make at the end of your pension is whether to purchase an annuity and if so which one.
Well firstly I hear you ask “what is an annuity?”
“An annuity is a regular income paid in exchange for a lump sum, usually the result of years of investing in an approved, tax-free pension scheme”.
So that is the technical definition of an annuity but what does this really mean?
Basically you save your money over your lifetime to build up a cash lump sum. When you retire, you give this lump sum to an insurance company who in return gives you an income for life. On death, depending on what type of annuity you take out, there may be a widow’s pension for your spouse or the pension could simply cease.
There are different types of annuity. The vast majority of annuities are conventional and pay a risk-free income that is guaranteed for life. The amount you receive will depend on your age, whether you are male or female, how much is in your pension fund and the state of your health.
Are they good value?
Falling interest rates, poor stock market investment returns and greater life expectancy have seriously devalued annuities over the past decade. In the mid-nineties someone saving £500 a year into a pension over 25 years might have retired on an annual income of £13,700. Today the same savings would give an annual income of just £3,800.
However, supporters of annuities point out that they offer absolute security for as long as you live. No other product does this and given that life expectancy has been increasing rapidly, this is a major consideration. Level annuities will pay an unchanging income from the outset. The problem with this is that if your pension is to last for over 30 years then inflation will erode this level income. An alternative is to buy an annuity that offers payments that rise in line with the RPI, thus maintaining the spending power of your income.
Are they flexible?
No. Conventional annuities cannot be changed, transferred or surrendered for cash. This makes it essential to choose the best possible deal when the time comes to convert your pension savings into an income.
Many of the financial rules governing retirement changed on A-Day - 6 April 2006. But tax rules still state that individuals must use their pension pot to buy an annuity by the time they are aged 75. However, A-Day created an exemption as a result of lobbying by a small religious group, the Plymouth Bretheren, because of their opposition to insurance. Its members are allowed to set up what is known as an Alternatively Secured Pension (ASP). Under the ASP, the pension fund remains invested and the individual draws an income from it. There are strict rules about how much income may be taken. Any remaining pension fund must be used to provide an income for your partner or financial dependent upon your death. The government has tried to deter the use of ASP by imposing large tax rates on death (up to 82%).
Do I have to accept my pension company's offer?
Absolutely not, your pension company will want you to choose its annuity offering, but the law says you don't have to. Everyone has the right to use the 'open market option' – which gives people the choice to shop around and choose the annuity that best suits their needs. There can often be a huge difference between the highest and worst annuity rates available, often amounting to thousands over the average investor's lifetime.
How will health affect annuity income?
Some insurance companies will pay a higher income if you have certain medical conditions. Statistics show that people with some health conditions have a shorter than average life expectancy. These specialist insurers use this to your advantage: they will pay you a higher income because they calculate that, on average, your income should be paid out for a shorter period of time.
What else do I need to know?
Some older pension policies have special guarantees that mean they will pay a much higher rate than is usual. Guaranteed annuity rates (GARs) could result in an income twice or even three times as high as policies without a GAR.
“A-Day” on 6th April 2006 mentioned above allowed schemes such as QROPS/QNUPS to be introduced. If you have a significant UK based pension scheme and currently living or planning to retire abroad then a QROPS/QNUPS solution can provide significant benefits to you. This will enable you to release your income free form HMRC tax and without the need to purchase an annuity.
It’s important to find a qualified financial advisor who is independent such as Worldwidebroker, providing you with unbiased advice. They can talk you through all the options available, giving you peace of mind and allow you to enjoy the retirement you’ve earned! If you would like more information on QROPS then visit our website and download our free guide at www.theqropsguide.com .
You can contact me Daniel McGonigle, Managing Partner at WorldWidebroker on (+351) 91 279 2998 or daniel@worldwidebroker.pt
W: http://www.worldwidebroker.pt/contact2.html
The financial advisers trading under WorldWideBroker Portugal are members of Nexus Global (IFA Network). Nexus Global is a division of Blacktower Financial Management (International) Limited (BFMI). All approved individual members of Nexus Global are Appointed Representatives of BFMI. BFMI is licenced and regulated by the Gibraltar Financial Services Commission (FSC) and bound by the rules under licence number FSC00805B.
