Do I have to buy an annuity when I retire?
26-Oct-09 by Tim Moore
There are alternatives to purchasing an annuity when you come to retire and begin to draw an income from your accumulated funds, most notably drawdown:
An income drawdown plan is a plan which allows you to take a lump sum and, if required, an income directly from your Pension plans without the need to purchase an annuity.
Advantages
You can take a tax-free lump sum immediately to spend or invest as you wish. This can be up to a quarter of the value of your plan.
Subject to limits imposed by the Government Actuary’s Department, you will be able to plan in advance the level of income that you wish to take each year, so that you can take into account any other sources of income which may become available to you. There is no minimum income you must take.
You can start to take an income at any time from age 50 (55 from 6 April 2010), even if you are still working.
-You choose the funds that your plan is invested in.
You can structure your income to mitigate liability to personal income tax. By reducing your income in some years you may be able to avoid higher-rate tax liability.
The pension plan value (less any income withdrawn and associated charges) will continue to be invested for you. Depending upon investment returns, which can fall as well as rise and are not guaranteed, this may provide the opportunity to achieve sufficient growth to improve your ultimate benefits.
You can delay purchasing an annuity.
You can purchase an annuity with some or all of your fund at any time.
As you get older there is the possibility of annuity rates rising and providing you with higher income, although this is not guaranteed. This is because the older the person the shorter their anticipated remaining life span (assuming the returns provided by medium to long term gilts remain the same).
Potential death benefits may be greater than under the conventional annuity route.
The remaining pension plan value (i.e. the part of the plan not being used to provide income) can be returned to your beneficiaries, subject to a tax charge of 35%, but normally free of Inheritance Tax.
Disadvantages
There is no guarantee that your income will be as high as that offered under a conventional annuity.
If you are using income drawdown to delay the purchase of an annuity there is no guarantee that annuity rates will improve in the future, and consequently your income may be lower than if you bought an annuity now. The longer you wait the likelihood is that annuity rates will decrease the older you get.
The income taken must be reviewed at least every five years and depending on investment performance and level of income taken it may not be possible to maintain the income payments selected at outset leading to a reduction in the income you can receive.
Once you reach 75 the maximum income you can continue to withdraw from your pension plan reduces.
Once you reach age 75 you must take a minimum level of income.
The value of your pension plan may go down as well as up. Additionally, you may not have a sufficient fund available to purchase an annuity equivalent to the amount you would have received at outset by purchasing an annuity. Income payments may erode the value of your pension plan, if investment returns are not sufficient to make up the balance (including charges for the ongoing administration of the plan).
If you purchase an annuity there is a cross-subsidy between those that die early and those that live longer. This subsidy is lost if you defer the purchase of an annuity so greater investment growth is required to compensate for this.
Death benefits which are not paid to your spouse or dependants might be liable to Inheritance Tax.
Death benefits can be payable as a lump sum under contracts being used to provide income are subject to tax at a special rate of 35%.
You may feel that the prospect of future higher income does not compensate for the guaranteed level of income available today, and for the rest of your life, that a conventional annuity provides.
