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Annuity – Is It A Good Idea?Written on June 25, 2019 by Kirk Rice LLP

Annuity – Is It A Good Idea?
Financial Services Questions

The Question:

My wife and I are 60 years old and will have full state pensions in 7 years’ time. I have £300,000 in a pension fund and my wife has £180,000. I propose buying an annuity to give us an income of £1,000 per month, which gives us security for the rest of my life. Then we will use my wife’s pension to top up our income until our state pensions start. Each of our state Pensions are forecast to be £165 per week. We need £2,800 per month to enjoy ourselves at present, of which half is essential lifestyle costs and the other for our pleasure.

Kirk Rice LLP answers:

When you purchase an annuity, you only have one chance to make a decision that affects the rest of your life, which, if you both have good health, could mean that you are still living with the impact in 30 years time.

Over the last 20 years living costs measured by official inflation have nearly doubled. Inflation has averaged a little under 3%pa for the last 20 years, which probably sounds insignificant to you as you’ll recall periods when inflation has been over 10%pa. It’s also likely that your spending increases at a higher level than the government published figures suggest (because you will not buy the basket of goods they use).

Therefore, you should think about purchasing an increasing annuity to protect you from hardship later in retirement. Is the annuity you quoted a special offer from the provider and does it provide for your wife as well as you?

If the answer to those questions is no, then I believe you have selected an annuity income that never changes and that could be terrible for you both in the long run.

The other factor to consider is what happens if you die soon after starting the income and the impact on your wife after your death at anytime. An annuity can be guaranteed for any number of years. If you choose a guarantee of 20 years, it means that if you die within that period the remaining payments are made to your estate. However, that may not provide much comfort to your wife if you die in year 19 or later!

You could consider whether you add the option to pay an income to your wife after your death. A common choice would be to have an income of 50% payable to your wife if she survives you.  You can choose any level and could opt for a truly joint annuity that continues to pay the same amount as long as one of you is alive.

An example of the income payable on a joint basis (continues without reduction on death as long as one of you is alive) and increases each year with price inflation (RPI) is that it would start at about £460 per month. As it is your pension money it will be taxable on you. If your wife survives you and you die after age 75, she will be taxed on the income paid. Until you receive your State Pensions it may mean neither of you pay income tax. In 20 years’ time the income payable to you or your wife will still buy the same amount of ‘goods’ for you as now.

Other factors could improve the amount paid to you as an annuity: Where you live; any medical conditions or medication; smoking; drinking; height and weight.

You could also choose a short-term annuity for the next 7 years, which means you get to decide again when you start to receive your state pensions and re-assess your needs. Annuity rates will increase as you become older. At age 70 the inflation linked annuity income on the same basis as I quoted above rises to £671pa.

There are several choices to be made and an annuity may not ideally meet your needs. You do not mention whether you have any tax-free cash in your pension to be considered as well. Generally, 25% of a pension fund is available tax free.

Many people in retirement find it difficult to predict exactly what their income needs will be in a few years’. Although an annuity offers security, you need to be sure that you don’t regret the choices you make in the purchase. A fixed term annuity pays you a certain income plus a known capital sum at the end of the short term.

Just because you link your annuity to the government inflation measure does not mean it will match your real needs in the future as inflation in your lifestyle expenditure could be very different.

Once your state pensions start there will be a different situation to today and it’s possible that an annuity you buy today might prove not to be ideal then. You may be able to manage any income tax liability with some pension products that you cannot do with annuities.

You may have heard about flexi access drawdown, and of course may have dismissed this alternative to an annuity because of investment risks that would be involved. However, I hope I have shown that buying an annuity is not a ‘risk-free’ option.

You should find talking to an independent financial adviser will help you arrive at the most efficient way to use your pension money in retirement. It could be a combination of different types of annuity and pension products is better suited to you both.

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If you prefer to research the annuities on offer. I suggest you go to the following government funded website (click here), which I used in providing you the guidance offered:

Any reader interested in discussing the annuity option can call 01344 875 000, 01252 960 500 or 0208 789 8588 or email info@kirkrice.co.uk to speak with one of our financial planners or email info@kirkrice.co.uk.

Please note: answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made. The information is based on current tax legislation which may change in future. The FCA does not regulate tax and trust advice.