You can use your pension or part of your pension to buy an insurance product called an annuity. An annuity is a long term contract between the owner, the annuitant, and an insurance company, that pays you a fixed payment. You can receive income payouts for a fixed number of years (temporary annuity, or fixed-term annuity) or alternatively, you can receive an annuity income for the rest of your life (lifetime annuity). Your payouts can start immediately or they can be deferred. Once you start receiving an income, you cannot outlive a lifetime annuity. You can receive your payments monthly, quarterly, annually or even as a lump sum depending on the type of annuity.
Annuities work by transferring risk from the owner, to the insurance company. Just like other types of insurance, you pay the insurance company premiums to take on this risk. Annuities can be paid for as a lump sum, or purchased with regular payments over time. The period in which you pay the premiums into your annuity is known as the accumulation phase.
Annuity incomes are based on a recipient’s life expectancy, with smaller payments received over a longer period. The amount of income you will receive depends: your health and lifestyle; the size of your pension pot; annuity rates at the time you buy; where you expect to live when you retire; how old you are when you buy your annuity; and which annuity type, income options and features you choose.
The younger and healthier you are when you start receiving payouts, the longer you are expected to live and consequently, the smaller your payments will be. The older you are when you start receiving payouts, or if you have a have a medical condition, are overweight or smoke, the payouts may be higher. You may also be able to get a higher income by opting for an ‘enhanced’ or ‘impaired life’ annuity to pay for any medical conditions. These are not offered by all annuity companies, so you need to shop around.
The main difference between an annuity and a pension is that you buy an annuity to provide you with a guaranteed regular income, whereas you save into a pension on a regular basis throughout your life.
Although it is not necessary to buy an annuity to finance your retirement plan, it should still be considered, as it provides a solid income foundation on which to base your long term portfolio. A strong annuity provides financial peace of mind.
Type of annuity:
Annuities are highly customizable. They can be structured to pay you a guaranteed income for the rest of your life. A joint- life annuity will continue paying a beneficiary such as your spouse if you die within a specified timeframe.
There are many different types. Finding an annuity that is right for you depends on two major considerations: What do you want the money to contractually do? And when do you want those income payments to start? As with any type of investment fund, you should first seek the professional guidance of a regulated financial advisor before purchasing such funds. Once you buy an annuity you cannot change your mind, so it is important to get help and advice before committing to one.
- Charges or fees
- Your state of health
- The amount of risk you are willing to take
- Protection against inflation
- Others dependant on your income
- Once you buy an annuity, it cannot be changed
- The income from an annuity will be treated like any other income and subjected to tax.
- You want guaranteed income for the rest of your life
- You don’t want your savings / pension to fluctuate with the financial market fluctuations
- You want to keep up with inflation
- Once you have purchased your annuity, you cannot change your mind
- You want to remain invested in the financial markets for capital growth
- You have a short life expectancy
Annuities offer a simple means of guaranteeing an income for life after retirement. They are highly customizable and can continue to pay your heirs and spouse after you have died. However, it is important to seek professional guidance from a regulated financial advisor, to find the annuity that is the most suitable for your needs.