Every day we deal with new enquiries from people approaching retirement and wanting to take an income from their pension.
We’ve got a huge amount of experience helping people arrange their Annuity purchase, as well as advising them on other retirement options, and we are seeing the same mistakes being made time after time.
We thought we’d put together a quick guide, showing you the seven most common mistakes people make when buying an Annuity and how to avoid them.
1. Not shopping around for the best rate
This might sound obvious so why don’t more people do it? We try to find the best price for almost everything else we buy, but a large proportion of people still don’t shop around for the best Annuity rate.
Some people simply take the Annuity offered to them by their existing pension provider; others accept the first Annuity quote offered to them.
This makes no sense, after your house an Annuity is probably the largest single purchase you will ever make; if you buy the wrong house you can always move, but you are stuck with the wrong Annuity, it can never be changed!
Shop around, don’t take the first quote, and make sure you have got the best possible deal before you commit.
Our pension Annuity calculator can give an initial indication of the Annuity rate you can expect.
2. Thinking that Annuity rates will rise
Most people know that Annuity rates have fallen significantly over the past few years and the pace of decline has quickened during 2012 as gilt yields have fallen further.
We quote often hear people say “I’ll wait a couple of months to buy my Annuity, rates might rise” or “Annuity rates are bound to rise soon, I’ll buy my Annuity next year”.
Now, we could be wrong, but we can’t see any reason why Annuity rates will start to rise in the short term. Unisex Annuity rates are just around the corner, insurers are making plans to cope with Solvency II, gilt yields remain at an all-time low, and we are all living longer. In short we can see no reason why, over the next couple of years why Annuity rates may start to rise.
So what does delaying achieve? If we are wrong then you may well get a higher Annuity rate over the coming months. However, if we are right, or indeed if rates fall further, you could get a lower Annuity rate, plus you will have missed out on the income during the time you were delaying purchase.
3. Not checking whether you qualify for an Enhanced Annuity
This is similar to the mistake people make when they don’t shop around for the best Annuity rate.
An Enhanced Annuity can give you a better income as it takes into account factors to do with your health or lifestyle, which might reduce your life expectancy.
Our experience tells us that too many people don’t check to see if they qualify, in fact, we’ve even seen cases where IFAs haven’t checked whether their clients can get an Enhanced Annuity!
Even if you think you are in perfect health or have one or two issues which you manage easily on a day to day basis, for example raised blood pressure of high cholesterol, check to see if you qualify for an Enhanced Annuity. Even relatively minor conditions qualify, if you don’t check you’ll never know and you could be missing out on valuable extra income.
At a time when Annuity rates are at an all-time low, you should do everything you can to get the best possible rate.
4. Remaining invested in stocks and shares
We never cease to be amazed at the number of people fully invested in the stock market in the months leading up to their retirement.
Over the course of 2012 many people have seen the value of their pension rise in value, the natural inclination of many people is therefore to leave it invested in the hope that it will continue to grow.
But the reverse could equally be true.
Stock markets tend to rise gradually but are prone to large falls over short periods. The Eurozone crisis may no longer be in the headlines but that doesn’t mean it has gone away, if Spain, Greece or Portugal default it could trigger a significant fall on the world’s stock markets, as could an unforeseen terrorist attack or an escalation of the troubles in the Middle East.
Why take the risk of exposing your pension to a stock market fall, which could be dramatic, just for the possibility of a little extra growth over a very short period?
It makes no sense to us, move to a cash fund, which most pensions offer and protect the gains your pension has made.
5. Paying more tax because a Purchase Life Annuity was ignored
Most people who don’t need the tax free cash from their pension simply use 100% of their fund to buy an Annuity. But by making a simple change and using a Purchase Life Annuity (PLA) they could get a higher net income.
A PLA works like a normal Annuity, it provides you with a guaranteed income and you can add options such as guarantee periods and spouse’s pensions.
However, because it is bought with savings, or you’re your tax free cash, HMRC deem part of the income to be a ‘return of capital’ and therefore don’t tax it.
Given the beneficial tax treatment of a PLA, a higher net income can be produced if you use the 25% tax free lump sum to buy a PLA and the remaining fund to buy a normal Annuity, compared to simply using 100% of the fund to buy a traditional Annuity.
We’ve found that many other advisers don’t even mention PLAs to their clients; we can only guess as to why this is, because we know from experience that using a PLA can help people pay less tax in retirement and enjoy a higher income.
6. Missing out on guaranteed Annuity rates
Some older pension contracts have Guaranteed Annuity Rates (GARs), which means that the Annuity rate was set when the pension was taken out and is generally far higher than current Annuity rates.
We always check for our clients whether any GARs exist because they can be hugely beneficial.
If you don’t check you’ll never know, it could be the most valuable phone call of your life!
7. Not taking independent advice
We are not ashamed to admit to a certain amount of bias here, but with good reason we think.
If you arrange your Annuity direct with an insurer it isn’t a commission free option, they will simply pocket the commission they would have paid to an adviser themselves.
For that commission, or fee if you have agreed a no commission deal, an IFA should provide the following:
- Comprehensive review of the Annuity market
- Advice on whether an Annuity is the right option or whether Income Drawdown or a Fixed Term Annuity might be better for you
- Confirmation whether you qualify for an Enhanced Annuity or you have Guaranteed Annuity Rates
- Help you move to a cash fund to protect your pension from any stock market falls
- Discuss with you the merits of a Purchased Life Annuity
And they’ll generally fill out the paperwork too!
All this for the same cost, and sometimes much less, as if you went direct to the insurer.
Hopefully you will now know how to avoid some of the mistakes people make when they are buying an Annuity.
We believe that Independent Financial Advice really comes into its own here and if you need the help of our experienced team of advisers, even if it is to ask a simple question, do not hesitate to get in touch.