Most people use their pension funds to buy an annuity, which provides regular payments for the rest of their lives. But what are annuities and how can they affect your retirement income?
What is an annuity?
A pension annuity is a product sold by insurers that provides a retirement income in the form of regular payments for the rest of the annuity holders life.
Choosing the right annuity can have a significant impact on your retirement income - increasing or decreasing it by up to 20%.
The payments that you receive will depend both on the size of your pension fund and on the annuity rate that you are able to secure. Generally speaking, the higher this rate, the more money you should have to enjoy your golden years.
How do I choose an annuity?
On retirement, most people convert their pension fund into a guaranteed income annuity that pays out the same amount every month for the rest of their lives.
However, it is worth doing some research before making your choice as the type of annuity most suitable for your needs will depend on a number of factors including your age, health, lifestyle and retirement needs.
If you are concerned about inflation eating away your retirement income over the years, you can also choose an increasing annuity that pays out smaller amounts in the first few years but offers larger payments further down the line.
Couples, meanwhile, need to decide whether to take out a joint life annuity that will continue to pay out up to 67% of the original payments to the surviving partner should one of them die.
How do I go about buying an annuity?
With most pensions, you automatically have what's called an 'open-market option' (OMO), meaning that you can scour the market for the highest rate.
It is worth checking what your pension provider is offering first, though, as some companies offer guaranteed rates for existing customers that are likely to beat those available elsewhere.
You can get a financial adviser - specialists include Annuity Direct and Hargreaves Lansdown - to search the market for you. This is definitely worth doing if you think you may qualify for an enhanced annuity, for example.
However, you will have to pay a fee or a commission for their services, so why not call the Pensions Advisory Service on 0845 601 2923 first to get some initial advice for free.
Are there any alternatives?
In the past, you had to use your pension to take out an annuity by the age of 75. However, this is no longer the case and some pension savers choose to use income drawdown, with which you take an income direct from your pension fund while leaving it invested, instead.
There are a number of risks involved, though, including that the value of your pension fund could fall due to market volatility. It is therefore imperative to take independent financial advice if you are considering this option.