What is a Retirement Annuity?

Harvey Jones 

There's been a big fuss about retirement annuities lately, so you may be wondering what it's all about. You may even be wondering what an annuity is, and who should buy one. It's a good time to ask, because the cosy world of annuities is about to be turned upside down. From April, it will never be the same again.

Are Annuities Absolutely Necessary?

An annuity is an income for life that you buy with your pension pot at retirement (unless you belong to a final salary scheme). Most pensioners have been forced to buy an annuity before the age of 75, whether they wanted to or not. Many resented that obligation, because they want to spend their hard-earned savings how they like. Annuities are also restrictive, because once you've taken one out, you are stuck with it for life. You can't switch later if you change your mind or find a better deal. Plus there is the danger that if you die shortly after taking out an annuity, your pension funds will be lost forever. You can't bequeath the income to your children or grandchildren.

Chancellor George Osborne has now swept away the obligation to buy an annuity at retirement under radical new pension liberation rules. From April, you will be free to spend your pension on whatever you like, even a Lamborghini, as Pensions Minister Steve Webb has joked. You can use your pension as a cash machine, drawing funds whenever you need it and leaving the rest invested for future growth, through a scheme known as income drawdown. Better still, you will now be able pass any remaining pension pot onto your descendants when you die, free of tax. That's because Mr Osborne has now abolished so-called "death taxes" on pensions. You won't incur inheritance tax either. This radical, once-in-a-generation overhaul will kick in from April 2015. The announcement sparked an instant 75% fall in annuity sales, as pensioners geared up to exploit their new freedoms. So do they spell the death of the annuity? Not necessarily.

Are Annuities still Relevant? 

Annuities still have one major attraction, because they pay a guaranteed income that will last for the rest of your life, no matter what happens. If you use your pension as a cash machine instead, you could quickly blow the lot. Income drawdown may also be too expensive or complicated for people with smaller pension pots, and leaves them at the mercy of a stock market crash. You don't have to go the whole hog and use all your pension fund to buy an annuity. You could buy an annuity with some of your pot, to provide a secure basic income, then invest the remainder through income drawdown. This may give you the best of both worlds.

Ignore those who say annuities are dead. For many pensioners, they still have a key role to play.

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Reader’s Digest have partnered with pension and investment experts Flying Colours to provide you with the advice you need to identify which option is best for you. Call our pension experts on 0333 241 9919 or click here to visit our dedicated website to help you decide which path suits you best, so you are then able to access the appropriate advice.