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PENSION

Annuity

(Also called Compulsory Purchase Annuity)

Lump sum invested with a life insurance company consisting of part or all of the accumulated fund of a pension scheme, usually a personal pension, which cannot be returned. You receive a fixed income until you die. The income is higher the older you are when you start it although that does not mean it is better value because of mortality drag (for an explanation if you are on-line see page 15 of the consultation paper Modernising Annuities from the Inland Revenue).

Options, but with lower income, include a joint-life pension annuity where payments continue until the second death or one guaranteed to pay for at least 5-10 years even if you die within that period.

A few companies offer investment linked and with-profits pension annuities where the income depends on the performance of the underlying investments, the income may go up or down. Pension annuities linked to the Retail Prices Index are also available sometimes with a maximum increase of, say, 5% a year. The initial income is usually lower with an investment or index-linked annuity than with a fixed annuity, for examples click here.

Who can invest Anyone who has a pension scheme which is ready to be paid out (minimum age is 50 or 60 depending on the type of scheme) but drawing the pension is best left until you are over age 65 for men, 70 women, if you have the chance. You have to start drawing the pension once you are age 75 and the Government has decided not to raise this age.

How worthwhile From 6 April 2006 there will be more options in the way that you can receive the benefits from a pension policy, see Saving Towards a Pension. You can already take around 25% of your accumulated fund in cash and invest it elsewhere.

A pension is designed to deal with the problem of outliving your capital. At age 50 a man can expect to live on average another 26 years to age 81 and a woman another 29 years to age 84. At age 60 a man can expect to live on average another 22 years and a woman another 25 years. At age 65 a man can expect to live on average another 17 years and a woman another 20 years. At age 70 a man can expect to live on average another 13 years and a woman another 16 years. At age 75 a man has on average 10 years to go and a woman 12 years. So the worldwide fall in long term interest rates has reduced the attraction of fixed rate annuities.

Minimum Around £10,000, otherwise charges reduce the return.

Maximum None. Better value for larger amounts may be found.

Suitable Lump sums.

Money back Not possible. You receive an income for life.

Interest Fixed or increasing at a fixed rate or increasing by the Retail Prices Index. Rates depend on how old you are when you start and vary according to the type of annuity. For instance for a purchase price of £40,000 with a fixed annuity a man of 62 might receive £1,088 a year, whereas one rising by 5% a year might initially receive £753 a year although an RPI linked annuity might start at £828 a year.

Interest paid Yearly, half-yearly, quarterly or monthly. By cheque to you or direct to bank account usually in arrears. Less income is paid for more frequent payment.

Tax The payment is regarded as taxable earned income and should be declared on a tax return.

Fees to pay None.

Passbook None. Annuity contract.

Children Unsuitable.

Risk UK authorised life companies are covered by a 90% compensation scheme less 'excessive' benefits. For complete safety use an old established company.

How to invest Get an independent financial adviser to obtain quotations for you, try the companies below direct or check the latest quotes from the magazine Life & Pensions Money£acts. If you want to avoid inheritance tax, ask a chartered accountant, solicitor or other adviser for advice.

Where from Note the best companies differ at different ages and depend on whether it is a single or joint life annuity. Best companies can change. For an idea of what you are likely to get from your pension fund see the comparative tables provided by the Financial Services Authority or compulsory purchase annuities at Money£acts.

If you have been diagnosed as suffering from a serious disease you may get better value with an enhanced pension annuity previously known as impaired life annuity. You can also get better rates if you smoke cigarettes.

Other Types of Pensions
Saving Towards a Pension

Last updated 1 September 2008.