Annuities are a last-chance saloon for retirement savers, because once you have made an investment decision you cannot change your mind and switch to another provider.

Once you have signed up, that’s it for as long as you live, regardless of unknown factors like inflation, stock market rises and falls or interest rate changes.

An annuity is a simple investment – you hand your pension fund to an annuity provider and in return they will pay you an income for as long as you live.

Pension rules changed in April 2011 making annuity purchase voluntary instead of compulsory.
The alternative to buying an annuity is income drawdown.

Drawdown is taking money directly from a pension fund instead of investing the fund in an annuity that pays an income.

Annuity providers have agreed to encourage their customers to shop around for more competitive products.

Buy an annuity without comparing deals can result in retirement savers missing out on thousands of pounds of income during retirement.

Information about buying annuities is available from independent financial advisers as well as product providers.

Rates across the annuity market can vary greatly between types of product and providers. This is often called the ‘open market option’ – and here are some of the points consider when shopping for an annuity:

Annuity guarantees

A guarantee confirms the annuity will continue to pay an income for a set period if the first partner dies soon after setting up the plan – generally the pay out will last for five or 10 years. So, if an investor buys a five year guarantee and then dies after 18 months, the annuity will continue to pay out for another 3.5 years – until the fifth anniversary of the start of the contract.

Annuity protection

Different providers call these ‘money back’ or ‘value protected’ annuities. They are designed to pay compensation for investors who die before their 70th birthday.

The protection is taken for a set sum, and if the investor dies before age 70, any income paid is deducted from the sum assured and paid as a lump sum. The lump sum is taxable.

Enhanced annuities

Annuities are one of the few financial products that pay more to investors who risk dying earlier.

Smokers or investors in poor health can earn a significantly higher income from their annuity because the provider ‘bets’ on paying less because they will not live as long as fitter investors.
With some providers, enhanced annuities can pay out up to 20% more than a standard investment.

Enhanced annuities come in three types:

• Lifestyle annuities – these are for investors who the insurer feels may have contributed to am condition that reduces their life span, like smoking, obesity or high blood pressure.

• Impaired life annuities – for investors suffering from medical conditions like heart problems, cancer, or strokes.

• Immediate needs annuities – for investors who are terminally ill who need long term care. The income pays care bills until they die.

Escalating annuities

A standard annuity is a level plan – paying the same amount of income every year. An escalating annuity starts at a lower level, but increase every year. The rise can be set at a fixed percentage or index-linked to go up in line with inflation.

Flexible annuities

Flexible annuities give investors some control over changing circumstances by allowing them to adjust how much income to take, investments and death benefits.

A flexible annuity might let an investor change arrangements for drawing income when the first partner dies.

Single or joint lives

If you are married, then this option does not apply. Basically, the difference between these is a single life annuity stops paying out when the investor dies, but a joint life investment continues until the surviving partner dies.

Some joint life annuities let the investors decide how much is paid to the surviving partner or guarantee payments. Choosing one or both can reduce income from the annuity.

With-profits annuities

These are speculative annuities for investors who do not mind taking a risk with their income.

With-profits annuities pay a lifelong income – but with a twist. The annuity provider invests your pension fund in a fund that returns a variable rather than fixed interest rate.

The gamble is if the fund makes profits, then you share the benefit – but if the fund piles up losses, you also share in those. Many set an ‘assumed bonus rate’ as an annual target return. Hitting the target means a bonus pay out, but falling short means settling for less income.

Over the past three years annuity rates have steadily been falling and have now reached the lowest level ever offered.

The stockbroker firm Hargreaves Lansdown have suggested that in 2008, a 65 year old man could buy a pension that would provide an annual income of £7,855 for £100,000, assuming that he didn’t buy one that rose with inflation and didn’t pay a widowers pension. The same amount would now only produce an annual income of £6,201. This works out at a 21% drop in annuity rates over the last three years.

A great number of pensioners who are retiring now face doing so with a far lower income than people who retired three years ago. Tom McPhail from Hargreaves Lansdown points out that this current level is the lowest since the modern annuity market became established in 1980s and is a long way from the 15% high in 1990.

Final salary pensions are not affected in the same way, but annuity rates for index-linked and joint life annuities have also seen a steep fall.

Experts suggest that the reason annuity rates have fallen so much is because the interest rates on government bonds (gilts) have also recently fallen to record lows. Annuity rates are linked to gilts and as they have fallen, annuities have suffered. Recently, investors have been purchasing more gilts as they try to avoid losses from the eurozone debt crisis. This has pushed the price of gilts up and led to lower interest rates.

Mr McPhail warned: “Annuity rates are at record low levels but there’s nothing to stop them going lower. Factors which could drive them down further include a Japan-style depression hitting the British economy and the introduction of equal annuity rates for men and women at the end of 2012.”

However Mr McPhail also added that interest rates could go up should the markets lose faith in the Chancellor, George Osbourne.

With the impact of interest rates on the annuity levels, many more people could see their income lose value over the course of their retirement. A recent report from Prudential has suggested that the spending power of a pensioners income could be reduced by 60% over a 20 year period, should inflation remain at its current level.

At present, the estimated average income for a UK pensioner is £16,600 per year. The impact of inflation on this income over a 20 year period could see this drop to a value equivalent to £6,700 in today’s money.

For the value to remain the same, the annual income would have to steadily increase to £40,000 over the 20 years. However, most pensioners are on a fixed income.

Inflation tends to have the biggest impact on people with low and fixed incomes. People who are retired tend to be hit disproportionately harder by inflation; they spend more money on essential items such as food and fuel which have seen significant rises in recent years. This ‘grey’ or ‘silver’ inflation has the effect of eroding the spending power that many pensioners have.

Age UK have recently suggested that whilst conventional RPI inflation stood at 3.1%, ‘grey’ inflation was up to 4.6% since the start of 2008.

Falling stock markets have wiped more than £120 billion off the value of British pensions in a month.

The staggering figure is equivalent to every retirement saver losing £2,000 from their pension fund.

Stock market losses have caused the value of pensions to plunge by 7% in the last month, says the National Association of Pension Funds (NAPF).

NAPF has monitored the value of defined benefit funds, defined contribution schemes and personal pensions between July 8 and August 8 to arrive at the figures.

During that period, the FTSE100 dropped below 5000 points for the first time in 12 months, although the FTSE has rallied slightly in recent days.

The message from NAPF chief executive Joanne Segars to pension savers is not to worry unduly but short-term problems like drops in share values and how the London riots might affect the stock markets.

“While we have estimated that the total value of assets in pension schemes has been reduced by 6-7% over the last month, funds are long-term investments and not easily unsettled by short-term volatility,” she said.

“On top of this, they are constantly monitoring market performance and spreading their investments across many asset classes. As we can see from this week’s stock market performance, prices can rise as well as fall.”

The fall comes only two weeks after the Organisation of Economic Co-operation and Development (OECD) released a report confirming pension funds across the world’s most developed nations had regained losses in the slump following the credit crisis.

The drop in share values is not all bad news, as pension funds can look at buying bargain shares that should readjust the value of investments in the future.

Many banks and stockbrokers are reporting a resurgence in trading activity as investors swoop on cheap investment opportunities that are likely to quickly regain value.

The mechanics looking under the bonnet of UK pensions all agree the vehicle is broken – but no one seems to have the manual for fixing the problem.

The ‘experts’ seem to fall in to two camps with opposing views of who is at fault and how retirement savings can be improved.

On the one hand are the innovators – pension engineers who want to dismantle everything under the bonnet and start again.

The opposite view comes from the maintenance men – pension providers and those with a vested financial interest who are blaming the drivers for mistreating their retirement savings vehicles and contributing to their own problems.

What the country does not need from either side is more reports. Everyone knows pensions are a problem and that the country cannot afford to bail out everyone over 65 years old who gives up work.

Retirement savers do not want anyone else to confirm the problem – they want a pied piper to lead them out of the mess.

Successive governments have brushed the problem under the carpet for too long in the vain hope the problem will go away.

It hasn’t and it won’t. Retirement savers have had enough words – it’s time for action. The problem is what to do.

The government has recently stated that any further tinkering with pension rules is out of the question for around five years. This timeline gives the NEST scheme that starts in 2012 a window to get up and running.

The hope is that NEST will solve the problem by enticing the missing millions who have no pension strategy to start putting money aside for their retirement.

Pension providers have thrown their support behind the scheme – well they would because the idea is more savers give them more funds to manage and more funds mean creaming off more charges to make bigger profits for their shareholders.

And there is the intrinsic problem with pensions and savings – the system is run by private organisations to make profits for shareholders.

Journalist and author David Craig has an interesting view on pension providers – his observation is UK pension pots are so small because the firms are overcharging investors.

Take average fund management costs from across the 29 developed countries across the Organisation of Economic Co-Operation and Development (OECD) and discovered fund managers in smaller economies take higher fees for running pensions than those in larger economies – except in Britain.

Here, the costs are from 1% to 3% a year against a backdrop of fund growth of around 4%. That means three-quarters of pension growth is disappearing in fees before the effect of inflation.

As an example, the best returns on pension investment were 10.3% in new Zealand but -8.1% in Portugal. The UK came in at number 22, just straying in to negative territory at around -0.3%.

“I calculated that pension companies are taking over £80 million every working day or £20 billion a year in fees and expenses from people saving for private sector pensions,” said Craig, writing in The Guardian newspaper.

“These unwarranted high takings make it almost impossible for private sector workers to build up sufficient money to retire with a reasonable pension income. Only a consistently roaring economy over 30 years would save the British private pension holder.

“A simple example illustrates the problem. If you had invested £100 in Warren Buffett’s company from the start you would now have stocks worth £300,000. But if you had invested it in Warren Buffett through a British pension fund you would have just £30,000 because of fees and charges.”

Pension companies argue that the problem lies with retirement savers.

Recent reports from Standard Life, Aviva and Prudential all suggest that pension pots are small because savers like to spend and live for today rather than invest and consider tomorrow.

Somewhere in the middle is the government. Ministers try to regulate pensions by imposing strict rules – then five years down the line another government comes in possibly with a different political flavour and changes the rules.

This happened with Labour in 2006 and the Tories in 2011 – although much of the legislation was already in play before the coalition won the General Election in 2010.

The latest report argues this gives pensions no stability – in the average retirement saver’s working life, the government can change nine or 10 times, wreaking havoc on long-term financial objectives.

Lord McFall suggests the solution is an independent pensions commission taking on this responsibility – but pensions are already regulated by numerous organisations starting with the Financial Services Authority.

Former government pensions adviser and secretary general of retirement group Saga, Ros Altmann comments: “Lord McFall is right that larger pension schemes should help lower costs overall, but the reality is that charges and risks will remain.  Trust has been undermined by too many scandals and savings levels are falling as workers struggle with the costs of everyday living.

“To make private pensions fit for purpose, we firstly need to radically overhaul state pensions and get rid of mass means-testing and then we need to radically overhaul private pensions, to ensure that they fit with people’s lives.

“Simpler savings products, more flexibility, lower charges and higher contributions would all make an enormous difference.  Coupled with radical annuity reform and more exciting products, such as a large lottery prize, we may finally start to rebuild confidence in long-term saving which has been so damaged in the past decade.”

Read the OECD global pensions report here

Over 55s have to make some tough financial decisions as they approach retirement.

The options are straightforward – retire with or without a tax-free cash lump sum or continue working to shore up retirement savings.

One reasonable yardstick is probably plan for now, because the economy is unlikely to worsen over the foreseeable future, so regardless of the current financial constraints, the stress on having enough money is likely to ease off.

Most over-55s at least want to ease their foot off the gas and have more time to relax or spend with the family, but for many, this modest ambition seems out-of-reach for those on average means.

If you are weighing up your retirement options and trying to figure out how to juggle those finances, here are the big five you must take in top account:

Inflation

Rising prices are the scourge of a fixed income. Inflation diminishes spending power by increasing the costs of basics while reducing the interest earned on savings. The government has steadily switched the measurement of inflation away from the retail price index (RPI) to the the more conservative consumer price index (CPI).

The difference between them is RPI includes housing costs, while the CPI does not.

The latest CPI figure for June is inflation running at 4.2% – down 0.3% in the month. RPI is 5.0%, down 0.2% since May.

The Bank of England target rate for inflation is a CPI of 2%, which governor Mervyn King admits is unlikely to be reached for at least two years.

Interest rates

Low interest rates are good for borrowers, who pay less interest on their home and bank borrowings, but not so good for savers who are paid miserly returns on cash on deposit.

Low interest rates coupled with high inflation mean a drastic reduction in real terms of how much every pound in savings can buy.

An interest rate of 3.5% on savings before tax means £1,000 is earning a rate of -0.7% even before tax is deducted at 20% or 40%.

The Bank of England has anchored base rates at 0.5% for more than two years, but rates will inevitably rise sometime – but probably not until next year unless the economy improves hugely and quickly.

Annuity rates

Annuity rates are falling and the smart money is on them falling even more over the coming months.

According to an annuity rate index maintain by pension provider MGM Advantage, rates dropped 0.18% for conventional annuities and 3.5% for enhanced annuities in the past three months.

Annuities share a seat with cash savings on an investment raft adrift on a sea raging from inflation and low interest rates.

Tax-free lump-sum

The tax free lump sum when reaching retirement is the carrot dangled in front of the eyes of many of the over 55s, but is taking the money worth it?

Research by pensions firm Prudential reveals that one in 10 (10%) of those who took a tax-free lump sum either now regret the decision or had not understood the long-term impact taking the cash has on their retirement income.

For many, taking a lump sum on retirement is the most tax-efficient way to access some of their pension fund.

However, the way in which pensioners use the money from their lump sum is often shaped by concerns around long-term retirement income.

More than half (52%) of those who had taken a lump sum put some of the money in a savings account and just over a quarter (26%) invested in stocks, shares or investment trusts.

A third (33%) spent the cash on home improvements, 31% paid for a holiday, and 19% bought a new car.

Taking the money reduces the size of the pension fund and the value of the benefits that are paid out.

Working on

A study by6 the TUC in to employment demographics over the past 20 years show a significant increase in the number of over-50s and people over retirement age still working.

Around 56.5% of people aged between 50 and 64 were working in April 1992 compared with 65% in December 2010.

Over the same period, the number of workers aged over 64 almost doubled from 5.5% to 9%.

The likelihood is as many over 55s worry about their retirement finances but still find they are fit and able to work, many more will opt to supplement their savings by staying in a job towards their 70th birthdays.

TUC General Secretary Brendan Barber said: ‘Older people bring a wealth of skills and experience to the workplace. The increasing number of over 65s in work shows that older workers are highly valued and that the government is absolutely right to scrap the default retirement age.

‘But there is a darker side to people to working beyond their retirement. Low wages and poor pension provision, particularly in the private sector, mean that many people simply cannot afford to retire at 65. The failure of far too many employers to help staff save for their retirement is forcing these people into pensioner poverty and placing a huge cost burden on the state.”

Financial worries

More than two in five pensioners (43%) told the Prudential they face a ‘cautious’ retirement as they worry about having enough money.

Despite these concerns, 79% of those drawing a company or private pension in 2011 took a lump sum on retirement, compared with 76% three years ago.

Vince Smith Hughes, head of business development at Prudential, said: “Most people with a company or private pension fund choose to take a tax-free lump sum at retirement, and for many this proves to be the right thing to do.

“However, some pensioners are beginning to regret the way they used the tax-free cash. The days of buying a shiny new car or going on a once-in-a-lifetime holiday may be gone, to be replaced by making savings and investments with the lump sum to supplement retirement income.

“There is no one-size-fits-all answer to the financial choices that people need to make when they retire. For example, spending the money from a tax-free lump sum and taking a level annuity with the balance of your fund will effectively fix the level of your retirement income – and for some this may provide the stability they need. Others may wish to explore more flexible retirement products that take into account the effects of inflation.”

Aviva has recently launched a new fixed term annuity plan that it hopes will appeal to the mass market of annuity shoppers. The new fixed term annuity product is designed to give people the option to take greater risk with part of their investment and have the potential to gain greater rewards in the long term.

The fixed term plan offers the investor two different investment options. The first option guarantees a maturity value to the investor and is the low risk option. The second option carries a greater risk but gives the investment the potential for greater growth.

The minimum purchase price for the fixed term plan is £30,000 and the investor can decide how much money to place in each option. After deciding how much tax free cash and income they wish to take, the investor can choose to invest a part of their money into either a guaranteed maturity value or the Aviva guaranteed fund.

The guaranteed maturity value locks the investment into a guaranteed growth plan in a similar way to Living Time products. If you choose to invest in this fund it carries a fixed term of 5 years.

The Aviva guaranteed fund has a term of between 5 and 10 years and comes with an equity backing of between 25% and 30%. What is left is then placed into assets such as corporate bonds which carry a fixed interest rate. This guarantees investors to at least get their money back from the initial investment.

At the end of the fixed term, the investor can then choose to invest in a new annuity or can go into drawdown. The product also includes death benefits as standard.

Aviva believes that this new fixed term annuity product is a valuable tool for any investor who decides not to retire from work completely and take up part time work instead. Clive Bolton, the retirement director at Aviva, indicated that the regular Real Retirement Report, which Aviva produces, shows that the retirement market changes rapidly, adding: “No two people are alike and individuals are approaching retirement with very different ideas about how they would like to spend their life after work.”

Darren Dicks, head of retirement, confirmed that Aviva are monitoring the success of the product. He is hoping to gain as much feedback from their customers as possible. Should it prove to be a success, they would also consider expanding the investment options available on the plan.

The managing director of Informed Choice Martin Bamford indicated that there has been much speculation regarding these “third-way” products, with many people suggesting that they will take over the UK market. He believes that until now, they have proven to be an unsuccessful product as most clients at the start of retirement prefer to either have the absolute certainty of an annuity or they want to go down the unsecured pension route. Furthermore, he indicated that there are not many people who want to invest their money into both options.

The UK government’s Pensions Minister Steven Webb suggested that people need to consider which savings option will provide them with a long-term retirement income. Mr Webb claimed that retirees would have little cause for concern if they knew that their annuities were sufficient for them and their family. Insurers provide people with the information that they need to buy annuities and ease the pressure on the national pension system.

Financial experts suggest that insurers need to find new ways to encourage existing and future customers to save for their retirement. Retirees can use their open market option if they find that they can receive a better deal from another insurance company. Studies suggest that people do not have the knowledge to make the best financial decisions for themselves. They claim that people need to be educated if they wish to achieve financial success.

Insurance staff and financial advisers are available to help people make the right financial decisions at retirement. It is important that people make the right financial decisions otherwise they will likely spend more than they intended.

Analysts suggest that annuity rates will continue to fall as pension pots decrease.

People will likely find that they need to save more than they currently do or work until ill health forces them into retirement. People need to know what financial solutions are available for them to take advantage of if they wish to save for retirement.

Recently here at annuitysupermarket.com we have had news of several providers increasing annuity rates, in fact one particular provider increased rates twice within a week. This news is very exciting given that recently we have seen numerous rate decreases and also rates the lowest for 15 years or more.

Laith Khalaf, pensions analyst at Hargreaves Lansdown, does not think this is the start of a sustained trend.
He claimed the Hargreaves Lansdown annuity index has risen for the first time since June 2009 which means a £100,000 pension fund will now buy a 65-year old man a level annuity of £6,428 compared to £6,291 a month ago, according to Mr Khalaf.

We asked Adam Benson, independent financial adviser and annuity expert at Retirement Solutions to give his opinion on the rate increases. Adam said, “Yes, there have been around 5 or 6 annuity providers increase rates over the last week, which is really good news for those annuitising right now. I understand it was down to rising bond yields, however, we are not expecting rates to increase considerably and in fact this may be just a blip and they could decrease again”.

Annuitysupermarket.com source rates from the entire market so you can be sure of getting the best annuity rates for your personal circumstances.