Can an annuity be tailored?

Can an annuity be tailored?

The annuity should be tailored to suit a member’s circumstances at the time of retirement. 

A member needs to decide if they want an annuity that is:

• Single or joint life
• Level or increasing
• With or without overlap
• Paid monthly, quarterly, half-yearly or annually.

In addition the member will need to consider if:

• A "guarantee” period is required
• He or she would like the amount of income to reduce at some point in the future.

We will now consider these choices in more details.

CHOICES  - THE SHAPE OF THE ANNUITY

The annuity is tailored to suit the member’s personal circumstances so they need to choose what is best for them.

Some of the choices will affect the amount of pension the member receives. 

Note – not all annuity providers will offer all shapes of annuity.

SINGLE LIFE OR JOINT LIFE?

A single life annuity will provide a higher pension than a joint life annuity but when the member dies, their spouse or partner will not receive anything.

If the member is married or has a partner then they need to consider if they want any income to be passed on if they die first.

The member can choose the percentage to be paid in the event of death, most people choose 50% but remember, the greater the "dependant’s” pension, the less their own pension will be from the outset.

The member should also consider the health of their spouse or partner as if they are likely to die first, any allocation of pension would be lost.

Prior to April 2015, income could only be paid to a "dependant” however, that restriction has been removed which means that joint life annuities can be set up to be passed onto any nominated individual when they die.

LEVEL OR INCREASING?

A level pension remains just that, the income at the outset remains the same amount every year until the member dies.

The member needs to consider the effects of inflation. If the member expects to live for a long time then in future years the income will be worth less in real terms than at the start.

With an increasing pension the member can choose either:

• An escalating annuity – the member chooses the percentage rate that the pension will increase by each year e.g. 3% or 5%
  Or
• An index-linked annuity – the increase is linked to an index such as the Retail Prices Index (RPI) or the Consumer Prices Index (CPI). This could also be limited e.g. the pension will increase by the CPI up to a maximum of 3%pa.

If the pension is to increase then the amount at the start will be lower than a level pension.

For lifetime and short-term annuities purchased after April 2015 a member will also be able to decrease the amount of income received. This relates to the greater flexibility being made available; when the annuity contract is set up a member can choose to take taxable lump sums hence the amount of income may need to reduce over time.

GUARANTEED?

Once purchased, a lifetime annuity is payable for life. The member can also, however, choose a guaranteed period. This means that the insurance company guarantees to pay the annuity for a specific number of years. Typically guarantees are for 5 years and the maximum guarantee period was 10 years. For annuities set up after April 2015 the 10 year limit no longer applies.

For example if a member has a 5 year guarantee but dies 3 years after retiring, there are two years left of the guarantee. Two years’ worth of pension payments would then be paid out to the member’s beneficiaries either as a lump sum or as continuing pension payments.

WITH OR WITHOUT OVERLAP?

If a member is purchasing a joint life pension with a guarantee period then they will also need to choose when they want the spouse’s pension to start. The main thing the member needs to consider is whether the spouse needs two incomes so soon after the member’s pension started.

With Overlap

This means that if the member dies within the guaranteed period their annuity will continue until the end of the guarantee period and the spouse’s pension will also be paid from the member’s death, so the spouse will receive two incomes during the remainder of the guarantee period.

Without Overlap

This means that if the member dies within the guaranteed period their annuity will continue until the end of the guarantee period. 

However, the spouse’s pension will not start until the end of the guarantee period, so the spouse will only receive one income during the remainder of the guarantee period.

INCOME FREQUENCY?

When purchasing an annuity the member can normally choose how often they wish to receive the income:

• Monthly
• Quarterly
• Half-yearly
• Annually

If the annuity is small then the insurance company may not offer a choice; very often small annuities are paid annually.

The member needs to think about this alongside any other income they receive to make sure they have sufficient monies at the appropriate times to support their expenditure.

ANNUITY COMPARISON

Look at the table to see what difference some of the choices you have just learnt about can make to the income.