Lieutenant Commander David Marsh Royal Navy of the Forces Pension Society writes for Pathfinder…
As we each near the end of our ‘working’ life, most of us will be asked to make one of the most difficult, yet important, financial decisions of our lives: the purchase of a lifetime annuity. We bathe in the comfort of a final salary pension from our Service career and reap the rewards of years of contributions via National Insurance payments that entitle us to a State Pension that is fully index linked too.
However, most of us are not lucky enough to have had a second career that will provide a second fully indexed final salary pension; we will have saved for our second career pension through a private pension plan, or perhaps a company’s defined contribution pension plan. Either way, it means we must spend our hard-earned cash wisely, to ensure it provides us with as good an income as possible throughout the remainder of our lives.
There are over 30 annuity providers in the UK, all eagerly rubbing their hands in anticipation of receipt of your pension pot. Choose your provider wisely, since you get only one shot at selection! There is no room for complacency here. Once you have made your choice and the annuity is put into payment; that is pretty much it for the rest of your life. The good news is that, contrary to popular belief, you do not have to buy your pension from the same company with whom you have been saving hard. Tout around, seek out the best deal: it is your money after all is said and done, and you could improve on your return by as much as a staggering 30%.
Let us look at a sensible list of things to consider as we go into this process:
1. You are allowed to take up to 25% of the value of your pension fund as a tax-free lump sum. There are many potential reasons for doing this; not least it allows you total control over that portion of your pension plan savings. Is that important to you?
2. Seriously consider buying a ‘guaranteed period’. This means what it says - the company will guarantee to pay your pension for a period (usually five or ten years), whether you live to see it or not. For example, if you hand over £100,000 to an annuity company to buy a level annuity of, say, £7,800 per year and you die one year later, you might feel slightly aggrieved that, after all your hard work, you and your family only saw £7,800 of that £100,000, and the annuity company got to keep the other £92,200 for very little work! However, if you had purchased a ten-year guarantee it would reduce your pension by approximately £250 per year (£7,550 instead of 7,800), but would have meant that your family/estate would have received, as a tax-free lump sum, the remaining £67,950 of the guaranteed £75,500 the annuity company promised to pay.
3. Next to consider is whether you want (or need) to have widow(er)s’ benefits attached too. The old AFPS75 scheme pays out a maximum of 50% pension to a widow(er); AFPS05 pays up to (and does so in most cases) 62.5% pension to a widow(er). This higher rate is more representative of modern-day thinking - ‘just because there are only half the occupants in the house after a spouse has died, doesn’t mean that all bills reduce by half!’ Let us, as an example, decide that we would like to have 66.66% of our pension paid to our spouse if we should predecease him/her (and still have the ten-year guarantee period too). Our £100,000 will now buy an annual pension of £6,800, reducing to a £4,533 widow(er)’s pension if we predecease our spouse.
4. Do you want to protect your pension from inflationary pressures, just as your Armed Forces Pension and State Pension are? This is an expensive option. Most annuity providers will offer you the choice of an annual increase at the set rate of 3%, 5% or the flexible Retail Price Index. It is quite possible that you might consider it unnecessary to have this pension protected in such a manner since your Armed Forces and State Pensions are already fully inflation proofed. However, I would suggest that most of us would seriously consider some form of protection, just in case prices ever do take-off again. In our example, therefore, I am going to assume we have elected that a set figure of 3% would not be unreasonable. If this option were to be taken it would reduce our annual pension from £6,800 to £4,800 (£3,200 for widows). It makes you realise how valuable a commodity your Armed Forces and State Pensions are!
5. Are you a smoker? If you are you must declare it and, for once, it will not have a detrimental effect on your pocket, but quite the reverse! After accepting all of the above three additional benefits you could quite easily see your annual pension rate increase by £310 to £5,110. Similarly, if you suffer from ill health (suffered a stroke or heart attack, or any medical condition) that is likely to curtail your life expectancy, some specialist annuity companies will offer an enhanced rate, depending on the condition etc. Again, shop around - don’t sell yourself short.
This is the first instalment of this fascinating, and ever-changing subject, and is just a simple beginner’s guide to annuity purchase. Next time I will look at what options are open to you with regard to postponing the purchase of your annuity and whether you might consider an investment-linked annuity. Also, for those with large pension pots, we will consider the possibility of buying lots of small annuities as opposed to one big one to get better value for money.