Like U.S. workers, the British have seen their pensions take a beating recently. Hard-earned savings have been eroded by economic contraction across the Eurozone, which is having knock-on effects in the U.K. People in retirement and those close to retirement age are having to rethink their spending habits and cut down on treats they’d been looking forward to enjoying in their retirement for their entire working lives.
A new survey by Primetime Retirement has found 36% of over-55s are cutting back on spending in certain realms of life including going out, 65%, holidays, 62% and buying clothes 61%. This is because of falling real incomes for the over 55s. For people ages 55 to 64 £318 per week is the average income. However for over 65s this rate drops by 24%.
As a result people are looking for alternative forms of income to their standard pensions. One option to consider is a pension annuity.
A pension annuity converts money locked away in your pension scheme into a regular income. Most people in ‘defined contribution’ pension schemes have to use their pension fund to buy an annuity, which, because it works like an income, is liable to income tax.
There are many types of annuities, and the market is filled with annuity providers claiming to offer the best rate. Before purchasing any kind of annuity it’s important you seek sound professional financial advice. The Money Advice Service is a good place to start before contacting a financial advisor. It offers an annuity comparison table to compare various annuity providers and types of packages to find one that works for you. You just have to fill in a few financial details and the comparison page is then tailored to your requirements making it an effective way of starting your search.
In the U.S., it is important to consider your own circumstances carefully when thinking about investing in annuities, which in this country are a type of insurance product. Although for some people they can be a reasonable part of a larger plan, for most people they’re not the best choice, for the following reasons:
a) Some (but not all) annuities have no provision for inflation-adjusted increases. Thus, although I might get a 6% return on investment by putting a chunk of money in an annuity today, 6% on, say, $100,000 would give me $6,000 now and evermore, whether or not the company issuing the annuity invested my money so that in grows or falls in value.
Thus in 20 years at a reasonable 6% return on investment, my $100,000 might have grown to about $320,700 if managed professionally in a diversified portfolio. But I would still be getting only $6,000 a year…which in the year 2032 ain’t gonna buy much. The annuity issuer would have paid out $$120,000 to me; but it would make a profit of $220,000 on the investment of the $100,000 I handed over at the outset.
If instead I kept my money, had the principal managed professionally, and drew down a more conservative 4% from my investment, at the end of 20 years I would still have control over my entire fund. It would not amount to $320,7oo, but assuming a 6% growth rate and a 4% drawdown rate, I still would have more than $100,000 in savings.
b) When your money is in an annuity, it is tied up permanently. If you need it for some unexpected reason (say, you or your spouse has to go into a nursing home and without it the person will end up in a grungy Medicaid home), you can’t get it back.
c) No matter when you die—whether you live to a ripe old age (God help you!) or you drop dead tomorrow—the money may not go to your heirs. Thus you leave your offspring without the financial capital that they should reasonably expect to inherit as members of a middle-class or higher SES family. Some annuities continue to disburse payments to heirs until the end of a specified period; others do not.
d) Most variable annuities have hefty commission charges and fees. These range from 5% to 14%. Other fees combine to make annuities a very expensive investment. There are no-load annuities, but these are not widely known and not used much. Regulations in the U.K. are undoubtedly different from those in the U.S.; investors need to familiarize themselves with what the laws in their countries allow insurance companies to charge for these products, and to know what the costs will be before deciding to invest.
e) In the U.S., annuities have some complex and onerous tax issues associated with them.
For some people, investing in an annuity is a smart move, and for some, not so much. Factors to consider include your age, your “fear factor,” your potential longevity based on your health and the longevity of your immediate relatives, and your projected income tax rates through retirement. Study the matter carefully before investing in annuities—or, for that matter, in any financial product—and consult a trustworthy financial adviser and a tax professional. Remember it’s important to get it right first time. There is no room for second chances in annuities; once you’ve picked, you cannot change your mind.
Image: Piggy bank from German bank HASPA, around 1970. Georgh HH. Public domain.
(I do not want my name or e-mail made public) Go to WalMart – Pharmacy section – and buy a Reli On Automatic Blood Pressure Monitor (just under $40). Type the forms in a PC program (I used Word). Put a form, the monitor, and a pencil in the second sink in the master bathroom. (Finally a use for it – YEA!) You need to get on top of your BP. My dr. and I agreed to take my BP once a day at the same time (8:00pm). Record some measurements so you have some data in hand to discuss with an md.
@ (Anon): Been there, done that. A year or so ago I got a blood pressure cuff and tested myself three times a day for two weeks. As long as I’m not in a doctor’s office with my feet hanging in the air off an examining table (check out the facts on what that does to your BP), my blood pressure and pulse rate are within the normal range.
Hey Standard Pension plans are necessary, i think every person should have at least one plan for their safety.
In the U.S., certain employers (such as state governments) still offer actual pension plans. In those cases, employees are required to take part of them, and contributions are willy-nilly withheld from pay.
A 401(k) or 403(b) is optional, I believe, and has the advantage that it’s funded with pretax money. However, its primary advantage lies in having the employer match the employee’s contribution. These plans have some significant disadvantages, not the least of which is that you can’t access your savings until you reach a 59 1/2, that the tax advantage goes away if your post-retirement income is comparable to what you earned before you retire, and that your heirs may lose a great deal of the principal to taxes.Thus for some Americans, self-disciplined contribution to ordinary brokerage accounts and a Roth IRA may be a better choice. For anyone in this country, really, whether you participate in a workplace plan or not, it’s wise to create a fund outside of the employer’s plan and contribute part of each paycheck to it.
Never thought about it till right this second, but I wonder what the Internal Rate of Return is on most pensions? Are they that terrible compared the annuities out there? or the fantastic GMIB annuities a few years ago
@ Evan: That’s an interesting question. Once when I had some money that had accrued in the state’s pension plan while I was working for the Dept. of Transportation and, several years after I’d quit, was still just sitting there. In a conversation with a bureaucrat at the pension office, I idly asked what the “interest rate” (my term, by which in my naivete at the time I meant “return”) was on those investments, and he said overall it was about 6%. Whether that would equate to the IRR in the context of a pension plan, I don’t know.
Your writer did not mention that it is usually not a good idea to get an annuity at a time of historically low interest rates. (Maybe the writer did; I didn’t read very carefully).
@ frugalscholar: Good point.