Annuities and open market option – Pensionfinder
With a defined contribution pension scheme – be it a personal pension or a group personal pension – when the time comes for you to finally retire, the money accumulated in your pension pot (less any tax-free lump sum) will be used to buy an annuity. This is an insurance policy which will provide you with regular income in retirement for the rest of your life. The payments would usually be monthly, but can be quarterly, half-yearly or even annually.
Once you have bought an annuity the funds accumulated in your pension fund are no longer yours, you have exchanged them for the income for life. When you die your annuity will die with you – you cannot pass it on to your children. You can, however, opt for an annuity which would continue to payout to the surviving spouse for life, upon the death of the other.
Annuities can also be set up so that they are payable to your beneficiary for a specified period (usually 5 or 10 years) even if you pass away before that period ends.
Members of final salary schemes will have their pension on retirement paid directly from the scheme so you won’t need to bother about an annuity.
Employees that are part of a company defined contribution scheme may find that the pension trustee of their scheme will organise the annuity for them. However, they should still find out about the options and make an informed choice.
Basic types of annuities
There are several types of annuities and it is important to make sure that you get the right annuity for your needs. To help you decide which type is right for you, you may want to get financial advice.
Here are the most common types of annuities.
Level annuity: the amount paid with this type of annuity remains the same for the rest of your life, so it will be affected by inflation.
Increasing income annuity: These increase each year and can be linked to inflation or by a fixed percentage each year.
Single Life annuity: These provide income for life for just the holder.
Joint Life: These suits couples, and will provide income for life for a partner after the death of spouse. These can provide income to just the surviving partner of the holder or can provide a lifetime income for whichever partner survives (known as joint life last survivor).
Guaranteed annuity: With this plan, income is paid for the life of the policyholder, but if they have an early death within the guaranteed period specified by the policy, the income will paid for the rest of the guaranteed period to the beneficiaries.
Impaired Life and Enhanced Annuity: These types of annuities work on the assumption that as you have a shorter life expectancy due to your lifestyle (perhaps you are a smoker) or health problems (say high blood pressure) you should get larger annuity payment while you’re still here to enjoy it.
Open market option
Usually, members of a personal pension will buy their annuity from their pension provider. However, it is important to realise that this provider may not be offering you the best annuity for your needs and/or they may not have the best annuity rate.
You are not obliged to buy your annuity from your pension provider and most providers will let your use your accumulated funds to buy from another annuity provider. This is what is known as exercising the open market option.
Exercising your open market option may allow you to increase your retirement income by taking advantage of more competitive annuity rates. If you are looking for a particular type of annuity, such as an enhanced annuity, you may find using the open market option useful.