Annuities

When a member of a defined contribution scheme wants to take pension benefits, there are two options - to purchase a lifetime annuity or to set up an unsecured pension.

A lifetime annuity is a contract bought from an insurance company. It is subject to similar rules as a scheme pension. The level of income will depend upon the size of the fund and on the current annuity rates at the time. There are also various options in terms of a guaranteed period in payment e.g. five or ten years. This means that, if death occurs within the guaranteed period, the outstanding instalments would be paid to the spouse or estate. Other options include the level of spouse’s benefits. These are normally ⅔ of the initial annuity. The rationale here is that the surviving does require more than ½ to meet the expenses of living on his/her own.

The annuity can be set up to increase by a fixed percentage, but this will have a detrimental effect on the early years. For example, when providing an annuity to increase by 5% p.a., it will be 8 years before the regular payment on an increasing annuity match the regular payments on a level annuity. In effect one could be out of pocket for about 16 years, without taking into account loss of interest.

A tax-free cash lump sum, of up to a maximum of 25% of the fund, is taken at the outset. The balance of the fund is used to purchase an annuity. Lifetime annuities are subject to income tax via PAYE.

As an annuity will be paid for the rest of the annuitant’s life, the life office needs to estimate for how long it will be paid. If an annuitant is in poor health, has particular medical conditions (for instance is a smoker or has diabetes) then a higher income may be obtained under an enhanced annuity, because the life office will expect to pay the annuity for less time.

For more information, please contact us.