Money Matters - Pension Annuities. "A guaranteed income for life"
After the success of the last five ‘money basics’ articles we are continuing this theme with a series of articles on focused subjects. The next five will be covering the overly complex subject of pensions in a little more detail.
As these articles are in a little more detail – they can be a bit longer, a 3 minute read instead of 2.
So what is an annuity?
After the pensions changes, the profession begun to prematurely decry the decline of the annuity and said the bottom would fall out of the market. We saw share prices of Legal and General and other big names in the annuity market slump almost immediately after the chancellors ‘shock’ announcements.
Now, people have realised that these Guaranteed Income For Life (GIFL) products (as they are now being called) are still an important part of the individuals financial tool-kit, and I’ll try to explain why here.
What’s the history?
The provenance of annuities is in the 19th Century. In the 1800s the British government issued a form of debt called an ‘annuity’. This meant that people lent money to the government and in exchange the government gave them a guaranteed income forever, and allowed the trade of these annuities.
Nowadays all British Annuities are gone, however ‘Gilts’ – other British National Debt – can still be bought and sold and it is the current yield of these which determine (in a roundabout fashion) what the annuity yield is, remembering that over time you are getting your capital back as well.
So how do they work?
In essence – you can use your pension funds to buy a ‘compulsory purchase annuity’ or other money to buy a ‘purchased life annuity’.
The life office (the company you buy it off) will then use that money to buy some gilts and provide you with the income they guaranteed.
Always, when looking at these, apply via an IFA and tell them to send off something called the ‘common quotation form’ – which allows the entire marketplace to look at your case in great detail and give a bespoke and accurate quote. The online portals are often wrong, and a company that could have been halfway down the league tables on an online comparison could actually be the best provider after giving them every detail about yourself.
Pensions are complicated – you need an adviser unless you are very experienced and suitably qualified.
The term ‘shape’ describes what options you go for, so in no particular order these are:
- Spouses benefit – this means how much of your income will continue to your spouse if you die. This can be any percentage up to 100% - where your spouse gets the same as you.
- Guarantee – the amount of time the pension company will continue to pay the income to your estate. If you have a 10y guarantee and die in year 5 they’ll often simply add up the remaining income guaranteed and pay it as a lump sum to your estate.
- Value Protection – which can effectively guarantee your estate the money back, less income payments
- Escalation – do you want an index-linked GIFL?
- Other options such as overlap and with proportion should normally be selected if available as they are cheap options that cost little yet have a potentially sizable benefit.
What about businesses?
GIFL can be used by big businesses too. If your company has a final salary with a problematic funding position for existing retirees then you can get a life office to underwrite the individuals concerned and they will offer to take the liability in exchange for some cash from your pension fund.
As a pension fund you can’t underwrite the individuals that are on your books and have to assume a liability until that person is dead. A life office can often take the liability off your books for a lot cheaper than the funding position required by your actuaries estimations.
It is certainly an area worth exploring with your IFA.
People often say that a GIFL is bad value. It is true that you normally have to live past your life expectation to get any real return from this – however the people who say that are missing the point.
A GIFL is For Life. If you have no other pension benefits then taking drawdown could be seen as high risk. One huge market crash could destroy your pension pot. If the life company providing a GIFL defaults then the FSCS will step in and continue to pay you 90%. So on drawdown your doomsday scenario is no more money and on GIFL it’s a 10% reduction.
You are paying for that safety with a GIFL – yes the potential return is very poor, but the potential protection against loss is very good and that is the trade-off.
So that’s it this week, next week we’ll talk about the opposite – flexi-access drawdown and how to instantly and inadvertently protect your estate against inheritance tax.
Our in house Independent Financial Advisors can help you with all aspects of financial planning including pensions, investments and inheritance tax planning. If you need any legal advice, please contact the Chattertons’ Wealth Management team at your nearest office.