Pros and cons of different annuity options

Annuities have traditionally been a popular way for people to fund their life in retirement, and Alistair McQueen, pensions manager at Aviva UK, argues they will continue to be so, despite the difficult period they have endured in the wake of the Budget.

He says: “An annuity allows you to hand your pension fund over to an annuity provider and they will then guarantee a certain income for the rest of your life, for as long as you live. Many people value this certainty.”

There are various types of annuities, each designed to meet different needs.

Mr McQueen says it is sensible to consider all options before purchasing an annuity as once your have made your decision and handed over your money to the annuity provider you cannot change your mind.

Individual, conventional: Often seen as the simplest type of annuity. It uses your client’s pension fund to provide them, and them alone, with an income for the rest of their life. When they die the annuity payments will stop.

Enhanced: Sometimes referred to as an ‘impaired life’ annuity, this takes into account health factors when setting guaranteed income. It is a refined version of the individual annuity and works on the basis that, if a client has a medical condition or their lifestyle features particular behaviours, they will have a shorter life expectancy and should get a higher rate.

Joint life: This product provides your client with a guaranteed income for the rest of their life - and will provide your client’s spouse, partner or financial dependant with an income for the rest of their life too. For children, the income will usually be paid until they reach a certain age; the rate will always be a proportion of the income they were receiving in retirement.

Inflation-linked: Typically these policies provide a lower level of income at outset, which then increases year on year in line with inflation. Often criticised as it can take a long time to reach the level available through a conventional alternative.

Investment-linked: Often referred to as ‘third way’ products, these can provide the possibility of achieving real growth above the rate of inflation through investment in equity based funds. By setting an assumed future growth level, policyholders can have an element of control over the initial level of income.

Fixed-term/deferred: The former offer a set level of income for a set period of time, with a maturity sum often paid at the end of the plan period which can then be used to provide an alternative source of income. Deferred annuities quite simply secure income at a set level available today, but payments do not commence until a defined point in the future.

Each annuity option will offer a different guaranteed income, and Mr McQueen says these incomes may also differ between different annuity providers.

While conventional annuities provide certainty and a guaranteed income for life, Richard Williams, director of The Annuity Bureau from JLT, says the fact they can not be altered if circumstances change post-sale has been under criticism.

Mr Williams says: “One advantage of a fixed-term annuity is that it provides a guaranteed maturity value at the end of the agreed fixed term, so do not leave policy holders exposed to investment risk.

“Another advantage is that they can be altered if circumstances change. For example, if the policyholder develops a medical condition or their spouse pre-deceases them, any subsequent income secured after the maturity date can reflect the change in circumstances which may result in a higher rate being available.

“The main disadvantage of a fixed-term annuity is the risk that an individual’s circumstances do not change and rates fall compared to those that would have been available if a conventional annuity had been purchased at outset.”

Mr Williams warns the main disadvantage of investment-linked annuities is that income levels could fluctuate from year to year so they are generally unsuitable for anyone wanting a predictable level of income, and while the level of income can fall, most products guarantee a minimum level for life.

He says: “One of the main disadvantages of annuity products is the associated death benefits, particularly given the most recent announcement regarding the removal of the 55 per cent tax charge on pension assets on death.

“For annuities, these are currently restricted to guarantee periods... or the inclusion of a widower’s pension.”