Pension Annuities Defined
A pension annuity investment is a financial plan that pays you a surefire income for a fixed period or a lifetime. Insurance companies mostly offer the product since it’s a form of an insurance policy. An investment plan is usually a contract with an annuity provider, and it gives you some cash, in exchange for a lump sum amount at the start, which is taken out from your pension pot.
There are several types of pension annuities in the market. Some pay you a fixed income, while other options pay some income that increases over time. You can also opt to take the joint-life annuity option that covers your spouse or civil partner.
Types of Pension Annuities
So let’s get down to business,
There are several types of pension annuity schemes. They include:
The Level Pension Annuity
It pays you the same amount of income every year. It features a higher starting income rate than the escalating annuity plan. Still, it can leave you susceptible to inflation, thus making your annuity savings worthless over an extended period.
An escalating annuity goes up every year at fixed rates. It might be initially lower than the level annuity, but the amount of income it pays increases at a fixed rate of about 3% per year.
An inflation-linked annuity plan increases every year in line with the retail prices index – which safeguards your annuity scheme against inflation hits. Nonetheless, it does start at a lower rate than its counterparts.
You’ll have to consider your situation like health issues, if you need to get an annuity income over short or long periods, and if you want to leave some income to your spouse or civil partner when you die.
Impaired or Enhanced Annuity
The pension annuity UK pays out a higher income than the level or inflation-linked annuities since it depends on how bad your health is. Therefore, if you have any existing health issues or are a tobacco smoker, or perhaps overweight, this is the best option for you.
The lifetime annuity1 pays you a considerable income amount for your lifetime, unlike the short-term or long-term annuity plans.
The joint-life annuity scheme pays you an income to your spouse or civil partner after you pass on. However, it’s usually at a low rate.
Short Term or Fixed Term Annuity
You have the freedom to use a percentage of your pension saving to purchase an annuity that offers you a short-term income. The remaining income amount is invested, and you can also opt to buy a lifetime annuity when your short-term plan expires.
It gets better,
You can also opt for the short-term scheme if you don’t want to commit your pension pot to a life annuity as the income rates might get better in the future.
Pension Annuity Rates You Need to Know About
A pension annuity works similarly to insurance products – all your capital is placed into a pool and paid out until you pass away. The pension investment plan is a guarantee of income for your lifetime. Therefore, the income rates depend on your life expectancy.
Those who get to close to beating Methuselah’s age record receive a larger share, while those who pass on sooner receive a small percentage. That’s reflected in the annuity rates. The longer you live, the lower the rates since the insurance lender will be paying for an extended period. For that reason, a 60-year old will get a lower amount than one who’s 70 years.
Medical issues are linked to life expectancy. If you have poor health, are an experienced smoker, or have other existing lifestyle conditions, you’ll be expected to have a shorter lifespan.
Therefore, you’ll receive a better annuity package, That also applies to the spouse or civil partner when it comes to joint-life annuities. Impaired annuity plans work on this basis and can offer you up to 30% more income rates.
The lower the interest rates, the less annuity income you receive. It’s because pension funds are partly financed by the interest received when your capital is invested. Thus you’ll receive less for your cash when the rates are low.
The best part?
As of 2020, the base rate is just 0.10%. Therefore annuity payments2 have been lowered.
A pension annuity is partly financed by government bonds referred to as gilts, that insurance companies purchase. In return, the government pays the insurer a fixed interest amount that’s dependent on the base rate and inflation curve. Therefore, when the base rate and inflation are low, the gilts become costly, and the interest rates (or yields) fall.
Making investments for your retirement is essential. However, before making any rash decisions, you need to consider:
- Talking to your pension provider to figure out your best options
- Receive pension annuity advice (you can contact the Pension Advisory Service for this)
- Beware of the pension scams circulating the market
It would be best if you also remembered that while you can receive the initial 25% of your pension savings untaxed, you’ll be charged income tax on any additional capital you take. Sometimes you might have to consider the effect it’ll have on your means-tested benefits or long-term care services.
Got Questions? Check These First
How Much Does A Pension Annuity Cost?
Some of the expenses associated with buying a pension annuity include:
- Administration fees – these include postage expenses and accounting
- Financial advice costs – your advisor might charge you a fee for the advice offered. You might be charged as a fixed fee or as a percentage of the ultimate purchase price
- Taxes – annuities are taxable. The annuity provider deducts tax before they offer you an income
If you need to figure out how much you’ll pay at the end, be sure to use the pension annuity calculator and get an informed estimate.
How is the Pension Annuity Taxed?
Well, the amount of tax you’ll pay on an annuity plan depends on the amount of income you get in that financial year and the tax rates in place. In the 2020/21 tax year5, every UK resident receives a personal allowance of up to €12,500, meaning that if your income is less than this amount, you’ll pay 0% in tax.
If, however, your income, including the annuity payments, surpasses your allowance, you’ll be liable to tax at the marginal rate. Some of the various income bandings and tax rates that apply to these amounts include:
|Income Band Rate||Income Rate||Tax Rate|
|Personal allowance||Up to €12,500||0%|
|Standard rate||€12,600 – €50,000||20%|
|Higher rate||€50,500 – €150,000||40%|
|Supplementary rate||Over €150,000||45%|
Is A Pension Annuity Worth It?
Yes, it is. One of the most incredible perks of the pension annuity is that it’s tax-free. Another benefit of taking out the annuity scheme is that some plans might not have annual contribution limits, meaning that you can make investments and accumulate an unlimited tax-free amount.
It’s incredibly lucrative to retirees looking to build their overall pension fund, as pension increases could result in increased inheritance amounts for heirs.
What’s the Difference Between A Pension and An Annuity?
Well, an annuity is typically a guaranteed income offer to you by a pension provider, in exchange for a lump sum amount. A pension, on the other hand, is a financial product that allows you to save some cash in a pot or fund throughout your life.
Pensions consist of various options which include state pension, defined contributions pensions, and the defined benefits pensions.
It all adds up to this:
A pension annuity is an agreement where a company will make payments to you for life in exchange for cash. Companies that offer this type of plan prefer individuals close to retirement age. Still, exceptions are depending on the policy and how much money has been accumulated by the employee. If you have accrued some savings from your job or other sources such as investments or inheritance, then it may be time to investigate if a pension annuity would work well with your financial goals.