Shop around for your annuity

The need to shop around for your annuity has rarely been greater according to Find.co.uk, consumer finance portal.

Research by the finance portal reveals annuity rates for 60 and 65 year olds have fallen by nearly 14 per cent over the last five years.

For example, a man aged 65 looking to purchase a single life annuity, with a five year guarantee, could have obtained an annual income of £828 in March 2002 with a £10,000 fund, compared with £718 today, a fall of 14 per cent.

And a woman aged 60 with a £10,000 fund looking to buy the same type of annuity could have received an annual income of £687 in 2002, compared with £588 today, a drop of 14.4 per cent.

However, there are ways of boosting your annuity income, such as by buying an ‘investment annuity’ whereby your income is linked to the performance of with-profits or unit-linked funds. In the case of a with-profit annuity, the hope is that your income will rise slowly over the long term but in the early years, the income may be no higher than a conventional annuity.

But this also means you have to be prepared to accept a fluctuating income, instead of the level payments of a conventional annuity.

You also need to consider the effect of life expectancy. A 60 year old man today has a life expectancy of another 25 years, whereas a 60 year woman can expect to live another 28 years. Accordingly, women suffer from lower annuity rates than men, meaning they need to save more in order to receive an equal pension to a man of the same age.

Another factor to watch out for when buying an annuity is inflation. The retail prices index grew by an average of 2.7 per cent a year between 2002 and 2007, so anyone who bought a level annuity five years ago will have suffered a drop in income of 13.5 per cent over that period. If inflation rose to 5 per cent a year, then income would halve in just 14 years. You can ‘inflation-proof’ your annuity, but this is expensive.

A 65 year old man with a £10,000 fund today could purchase a level annuity of £718 pa, whereas an annuity rising by 5 per cent a year would produce an initial income of only £422 a year – a reduction of 41.2 per cent.

Smokers (defined as anyone who has smoked at least 10 cigarettes a day for the last 10 years) and the obese can also improve their income by buying a ‘special’ or ‘lifestyle’ annuity. If you have a serious, life reducing medical condition, you may be eligible for an ‘impaired life’ annuity which will pay you a higher income because of your reduced life expectancy.

Kate Marsden, Marketing Director of Find.co.uk, said: “It is essential to use your ‘open market option’ which gives you the right to shop around for the best annuity rate when you come to retire and not just accept the rate offered by the company which managed your pension.

“If you are eligible for an impaired life annuity then using this facility could improve your income by up to 40 per cent, compared to that payable by a standard annuity, depending on the severity of your condition.”

Whichever type of annuity you buy, you will always need a hefty sum in order to obtain a decent income in retirement, particularly if life expectancy continues to increase.

To calculate how much your fund might buy at retirement, a woman should calculate (on a conservative basis) that each £100,000 will buy around £5,000 of income, so a £500,000 fund might buy you an income of around £25,000 pa. For a £50,000 income, a woman would need a fund of around £1m.

The good news is that annuity rates have been rising since the beginning of the year, with most of the major providers having increased their rates because bond yields have risen and because of competitive pressures.

Also it is important to remember that annuity rates don’t fall in a vacuum. Many people have seen their pension funds grow substantially in the last four years and have much larger funds than individuals who retired in March 2002 when the stock market was in the doldrums.