Retirement brings its own rewards and choices, but one decision which cannot be avoided when you turn 60 or 65 is the compulsory purchase of the pension annuity from the proceeds of your pension fund. Since it is the value of this annuity and its annual rate of return that will determine the size of your annual pension, our survey of the seven major annuity providers shows just how vital it is that you shop around and buy the one that best suits you and your family's needs.
How do pension annuities work? When an employee who has been a member of a "defined benefit" pension scheme retires, he knows that his annual pension will be a proportion of his final salary and years of service. His employer and the scheme trustees have made him such a promise and it is their responsibility to purchase an annuity which will meet this obligation. Employees who are members of "defined contribution" schemes, however, in which the final pension fund is based solely on the value of the contributions paid in, or someone with a personal pension plan, have no such guarantees. They (or their pension scheme trustee) must seek out the best annuity rate for the proceeds of their pension fund.
"With interest rates so low these days, and annuity rates varying from week-to-week and from company-to-company, it is important to shop around," says Paul Kenny of Irish Pension Trust, the biggest pension fund administrators and trustees in the State. Everyone, he says, should exercise their "open market option" and not automatically accept the annuity rate quoted by their original pension company. (If you hire a commission-based broker he will earn 2 per cent of your fund as commission. Fee-based independent financial advisers will establish a rate based on their time and expertise.)
The other reason for shopping around is that new products have been introduced in the last couple of years which provide greater variety and terms than conventional annuities, the value of which tended to be based mainly on age, sex and the price of gilts on the day. (Since women live longer than men, their annuity rates are always lower. Older annuitants die sooner than younger ones and so they will be offered higher rates.) It should be noted that the pension you finally receive will also be affected if you choose to provide your spouse or children with pensions after your death and whether you opt for a level or escalating pension or an indexed one.
In the past six months a unique "impaired life" annuity has come on the market which pays a higher rate to anyone with a history of a life-threatening illness such as cancer, heart problems or kidney disease. This product, from Norwich Union, is correcting a large anomaly in the life assurance market in which the person suffering from the medical condition is forced to pay over the odds for protection policies during his lifetime, but does not have his state of health taken into account when seeking a pension which he is unlikely to enjoy for as long as the healthy person.
Another relative newcomer on the annuity market is the guaranteed annuity offered by Scottish Provident. In this case it promises to pay a specific annuity rate, currently as high as 11.11 per cent for a male, aged 65, to anyone who takes out their with-profit pension contract. For many people, worried that the value of their final pension could be seriously affected by a sudden world financial crisis, this guaranteed annuity from Scottish Provident is very welcome.
The Equitable Life's unique "with profit annuity" addresses the problem of having to lock-in your pension at a fixed-gilt rate, which is highly susceptible to inflation. This product, also available on the open market, invests your pension fund in a with-profit fund in which stable returns are based on a basket of mainly equities and some gilts. The annuity rate tends to be a few percentage points higher than either their own or other company's conventional, gilt-based annuities.
Even the long-standing criticism that the annuity/pension dies with the pensioner (or the spouse, if they also receive a pension) is about to be addressed soon when an annuity that pays a lump-sum death benefit is introduced shortly.
With companies offering annuity rates currently ranging from 6 to 10 per cent for conventional products, and even higher rates for impaired life, guaranteed and with-profit ones, the scope for financial disaster is immense if the selection of the final annuity is not done carefully and on the open market. "When you buy an annuity," reminds Paul Kenny, "the decision is irreversible, and this is why it is so important to get it right."
