experts Prudential provide some expert advice on managing personal retirement finances.
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Understanding Pension Annuities How to turn your pension fund into an income – for life Introduction Before you can draw your pension, there are some things you need to know. Many people think that when they retire, their pension fund will automatically start paying them a well deserved income. However, the truth is that when you reach retirement age, you will have to decide how to convert your pension fund into a regular income. You can do this by buying a pension annuity. This handy guide from Prudential is all about annuity options. It shows you how you can use your pension fund to buy an annuity that will give you an income for life – no matter how long you live. There are many different types of annuities, all with their own pros and cons. We’ll show you what your choices are, so you can start to think about which one will be best for you. That way you’ll be able to make an informed decision in order to secure a comfortable income in retirement. And if you have any questions, we’re always here to help. www.pru.co.uk/annuities Introduction 3 Introduction Your way around the guide Annuities explained 1 2 What is a pension annuity and why should you buy one? Why an annuity makes sense Page 6 8 Things to consider 3 4 5 6 7 The effect of inflation on your retirement income If you have more than one pension A tax-free cash lump sum How your partner, health and other factors can influence your decision How much will you actually need in retirement? 10 11 12 13 14 4 Introduction 0800 0121 167 Introduction Making your decision 8 9 Types of annuity Find out where you currently stand Page 18 22 24 26 10 Key steps to taking your pension income 11 It could pay to top up your pension Taking action 12 What to do now 28 And finally Index of key terms 30 Information in this handy guide is based on our understanding of current taxation, legislation and HM Revenue & Customs practice, as at January 2009, all of which are liable to change without notice. The impact of taxation (and tax relief) depends on individual circumstances. www.pru.co.uk/annuities Introduction 5 Annuities explained 1 What is a pension annuity and why should you buy one? When you pay money into a pension during your working life, you build up a fund. If you have a “Defined Benefit” or ‘Final Salary Pension Scheme’, your fund will automatically begin to pay you a regular pension when you retire. If, like many people, you have another sort of scheme (usually called a “Defined Contribution” or “Money Purchase Pension Scheme”) then a few weeks before you retire you'll have to decide how best to use your pension fund to provide you with a regular income. Of the options available, the most popular choice by far is to buy an annuity. This guide helps you understand your annuity options. When you can start taking pension income Many schemes let you take your pension income any time between ages 50 and 75. However, new pension rules, due to come into effect on 6 April 2010, will increase the minimum age to 55. When you first took out your personal pension plan or retirement fund, you probably nominated a specific retirement age. If so, it’s unlikely you would be held to that. But if you’re retiring early, check that it won’t cost you anything as some older pensions have penalty clauses. 6 Annuities explained 0800 0121 167 An annuity is a form of insurance which guarantees to pay you an income for life – no matter how long you live. So you need never worry about your income drying up. This makes it safe and secure and gives you peace of mind. Annuities explained 2 Why an annuity makes sense No-one knows what the future holds, which can make it difficult to plan ahead. However, people are living longer and enjoying a more active retirement. Which is why an annuity is so attractive because it guarantees to pay a regular income, no matter how long you live. So even if you live to be 105 you can rest assured that the money will keep coming in. Statistics show that 18% of today’s 65-year old men and 29% of today’s 65-year old women will live into their 90s*. In the 1960s there were fewer than 300 centenarians, yet in 2004 there were more than 6,000 people over 100 years old in England and Wales, and by 2036 this number is predicted to increase to 39,000**. Figures like this demonstrate why securing an income for life is vital. Annuities can provide the security of an income for life. All you have to do is choose the right annuity to suit your individual circumstances. 8 Annuities explained 39,000 predicted The number of Centenarians in England and Wales** under 300 1960s over 6,000 2004 2036 *Source: www.lifetwo.com Good news, bad news: Majority of retirees underestimate life expectancy, October 2006. **Source: Economic and Social Research Council (ESRC), Swindon, page 32. (Accessed 16 January 2007). Stewart, I. and R. Vaitilingam (eds) (2004) Seven Ages of Man and Woman: A Look at Life in Britain in the Second Elizabethan Era. 0800 0121 167 Things to consider 3 The effect of inflation on your retirement income The cost of living in retirement is higher than you may think. In the early years you might decide to take up new hobbies or devote more time to old ones. You may also want to travel more, and visit friends and relatives abroad. Then as you get older and start spending more time at home, you may find that your utility bills rise. The increased cost of living, combined with the fact that you can expect to enjoy an average of 22 years* in retirement, means that an annuity that has the potential to increase your income over the years may be most suitable. Even if the Bank of England achieves its 2% inflation target, £1,000 in today’s money will be worth only £647 in 22 years’ time. *Based on PCMA00/PCFA00 mortality tables. The good news is that with an annuity you have various options that can help protect your retirement income from the effects of inflation. We’ll explain these in more detail later on. 10 Things to consider 0800 0121 167 Things to consider 4 If you have more than one pension Over the years you may have worked for a few different companies and paid into more than one pension with different providers. In this case you may want to combine your total fund value into one annuity. This could maximise your potential income, as some types of annuity require you to invest a minimum total fund value. However, you'll need to check each pension you have to see if this is possible – and financially beneficial. Annuities are believed to date back to Roman times Annuities have been around for some 2000 years and began in ancient Rome*. Outside the state pension, annuities are the most common form of pension income in the UK today**. * Early History of Annuities, Annuity Museum, April 2007 **www.ageconcern.org.uk www.pru.co.uk/annuities Things to consider 11 Things to consider 5 A tax-free cash lump sum to your funds for a special treat or for a ‘rainy day’. Meanwhile your tax-efficient funds will continue to gain interest. Normally you can take up to a maximum of 25% of your pension fund as tax-free cash. This means you'll receive around 25% less income from your annuity. If the total sum of all the pension funds you hold is less than £16,500* you can withdraw it all as cash between the ages of 60-75. However, you must withdraw all your funds in a single 12-month period. You'll normally be able to take 25% of the total fund as tax-free cash, while the remainder will be taxed as income. *Correct for tax year 2008/09 Before you start taking an income from your pension fund, you have the option of taking a tax-free cash lump sum from it first. If you do, you’ll receive less income from your annuity, but will come away with cash that you can use to boost your pension income in other ways. For instance, you could put your capital into tax-free or tax-efficient savings or investments. This will give you easy access 12 Things to consider 0800 0121 167 Things to consider 6 How your partner, health and other factors can influence your decision Like many people, you may want to ensure that your partner can continue to benefit from your pension if you die before they do. You can choose an annuity option that will ensure they can – though it means your income will be lower. Or if you suffer from poor health or have a long-term medical condition, you may feel that you will never receive the full benefit of an annuity. However, this is one instance where poor health can actually work in your favour. For instance, Prudential may pay you a higher income if you have a qualifying serious medical condition. This is called an Enhanced (or Impaired Life) Annuity. So it is important that you highlight any health problems to us. From ill health to inflation, there is an annuity specially designed to meet your needs. www.pru.co.uk/annuities Things to consider 13 Things to consider 7 How much will you actually need in retirement? Thanks to new found leisure time, you may find yourself spending more money than anticipated. Or you may discover that staying at home means higher bills – especially for gas, electricity and telephone. You may want to use the checklist on the following pages to help you estimate the amount of income you will need. You also need to think about whether you: > want to replace any employee-benefits you might lose (for example, a company car, mobile phone or medical insurance) and how much will it cost > may receive extra money in the future (for example, maturing insurance policies, endowments, bonds, investments, sale of a property or business, or inheritances) > would be willing to use or dip into your capital (for example, investing it for income, downsizing your home, releasing equity from your home or selling assets) to supplement your pension income 14 Things to consider 0800 0121 167 Things to consider Money Checklist Expected monthly spending Current monthly spending Total new spending once you retire (e.g. extra heating costs, health plan, car expenses, etc.) Less total spending that will stop or reduce when you retire (e.g. rail fare, petrol, lunches, etc.) Total per month (in retirement) One-off expenses in retirement Total required for one-off costs (eg. replacing a company car, planning the trip of a lifetime, installing a new kitchen or bathroom, moving home, etc.) You may have some tax-free cash from your pension that you could use. £ £ £ £ £ 16 Things to consider 0800 0121 167 Things to consider Expected value of assets in retirement Savings/Investments Your home (less mortgage) Other property/business interests Potential inheritances Total wealth (in retirement) Sources of income Income from savings or investments Your private/company pension Your partner’s private/company pension Basic (old age) state pension Additional state pension or other state pension or pension income Earned income from post-retirement work Income from equity released from your home Other income (eg. rental, property/trusts) Total expected income www.pru.co.uk/annuities £ £ £ £ £ monthly amounts £ £ £ £ £ £ £ £ £ Things to consider 17 Making your decision 8 Types of annuity There are many types of annuity and pension income options to consider and depending on your circumstances you may be able to choose one or a combination of these. On the following pages you'll find an overview of the main ones. Remember that you’re free to shop around for the most appropriate solution. This is called an “Open Market Option”. So before you retire, make sure you ask Prudential or your Financial Adviser for more information so you fully understand all your options. You can also get more information at www.pru.co.uk/annuities. Once you know your annuity options It’s important to understand that once you have bought an annuity you can’t change your mind, so you need to be sure you’ve made the right decision. 18 Making your decision A Conventional annuity with level income This basic type of annuity guarantees to pay you an income for life. It also guarantees the amount it will pay. The income will be fixed from the start and will not change until you die. Advantages: > Guaranteed income that will stay the same. Disadvantages: > The purchasing power of your pension income will be eroded by inflation over time. > No possibility of increases in income. > Once selected, it cannot be changed. 0800 0121 167 Making your decision B Conventional annuity with increasing income As its name suggests, this option allows you to choose an income that will increase over the years. The amount of the increase can be set at a fixed percentage each year, or linked to inflation using the Retail Prices Index (RPI). Advantages: Disadvantages: > Your starting income may be lower than with other types of annuity. > If you choose a fixed percentage increase, your income might become eroded by inflation over time. > Once selected, you cannot change your mind or change the level of increases. > Guaranteed income that will increase in line with RPI, or by the fixed rate chosen. > If you choose an increase linked to RPI, and inflation is negative, your income will go down (unless you choose to protect against this). > If you choose an increase linked to RPI, your income will be protected against inflation. www.pru.co.uk/annuities Making your decision 19 Making your decision C With-profits annuities A with-profits annuity can be arranged to produce a similar income as a Conventional Level annuity. Assuming investment returns are good, your income may increase and over the longer term may give some protection against inflation. If investment returns are poor, your income may fall. So with-profits annuities involve an element of risk – and potential reward. Your choice of starting income will determine the level of risk you are taking – the lower the income, the less risk there is. Conversely, the higher the income the more risk there is that your income could reduce in the future. Advantages: > Guaranteed minimum income. > Potential for increases in income, based on fund performance. > Potential to keep pace with, or even outpace, inflation. > Some (like the Prudential Income Choice Annuity) allow you to convert to a Level or Increasing Income Conventional annuity if you change your mind. Disadvantages: > Your income can reduce in years of poor fund performance, although not below a minimum guaranteed income level. 20 Making your decision 0800 0121 167 Making your decision D Unit-linked annuity Here you can choose to link your retirement income to the value of an underlying investment fund. The fund can be low, medium or high risk (depending on the offering of the provider). Usually the more risky the underlying fund, the more your retirement income may increase – or decrease. Also, most Unit-Linked annuities do not come with a minimum income guarantee. Advantages: > Potential for increases in income, based on fund performance. > Potential to keep pace with, or even outpace, inflation. > Some (like the Prudential Flexible Lifetime Annuity) allow you to convert to a level or increasing income conventional annuity if you change your mind. Disadvantages: > Income can fall. > Some do not offer a minimum income guarantee although this is available with Prudential’s Flexible Lifetime Annuity. > Highest risk annuity option – entirely dependent on investment returns. www.pru.co.uk/annuities Making your decision 21 Making your decision 9 Find out where you currently stand When working out detailed figures we suggest that you (and your partner, if appropriate) get up to date valuations for all your: State pensions and benefits You can find out about these on the Department for Work and Pensions’ website www.dwp.gov.uk The Government is setting up pension centres round the country to help retired people. To see if there’s one near you, visit www.thepensionservice.gov.uk > private or company pensions > state pensions and benefits > savings and investments (both their capital value and average yearly income/interest) > loans, mortgages, credit cards and other debts. Little or no pension If you have low pension income, you could be eligible for pension credit or other state benefits. To find out about these, contact your local pension centre or social security office, or visit www.thepensionservice.gov.uk where you can search for local sources of help. 22 Making your decision 0800 0121 167 Making your decision Divorce and your pension Lost track of any pensions? If you’ve lost touch with your pension provider, it’s important to make contact and let them know where you are. If you don’t know how to trace them, the Pension Tracing Service may be able to help. Call 0845 6002 537 or visit www.thepensionservice.gov.uk When couples split up, division of their pensions is usually decided at the time of the divorce. This used to be called pension splitting but is now known as pension sharing. Alternatively, pensions can be earmarked for division at retirement. If this applies to you, remember to take it into account and let your chosen annuity provider know – as it will affect your annuity quotes. www.pru.co.uk/annuities Making your decision 23 Making your decision 10 Key steps to taking your pension income The following timetable and checklist will help make sure you get the pension income that best meets your needs. Timetable of events As you get closer to retirement, you can check with your pension provider and/or chosen annuity provider to see how long things will take. Until then, these approximate timings may help you draw up a plan of action. 12 months or more before You should start thinking about what life will be like when you’ve retired. Consider topping up your pension and preparing for retirement (see page 26). 3-6 months before Get all your paperwork together and start looking at what options are available to you. You may want to ask your pension provider for a valuation – but bear in mind that this is likely to change by the time you actually retire. 8-10 weeks before By now you should have a reasonable idea of what your options are. Make sure you ask for a number of different annuity scenarios, such as Income Choice Annuity, Fixed Income, Increasing Income, Joint and Single Life policies. This will allow you to see clearly what your options are and how much you could get, both today and in future years. Decide which options best meet your needs, then call Prudential to discuss your choices and ask for a quote. 24 Making your decision 0800 0121 167 Making your decision If your needs change or you change your mind, there may still be time to back out. Normally the cancellation period is 30 days from the date of the first quote being issued, but some companies (at their discretion and depending on how far on your application has progressed) may allow you to cancel right up to the last minute. All being well, though, and with help from Prudential or advice from your Financial Adviser, you’ll have the confidence to start enjoying your pension income right on cue. You may also want to speak to a Financial Adviser to help you narrow down your options to a shortlist. 4-8 weeks before If you’re moving pensions from different sources, you need to apply 4-8 weeks in advance of your actual retirement date. Ask Prudential if you need help in understanding anything so you can make your final decisions. 2-3 weeks before Armed with all the information you need, you’re now in the position to make your final decision. In the final run up It normally takes several weeks between applying for your chosen quote and your pension being converted into pension income. So make sure you have access to funds to cover any possible gap in income. www.pru.co.uk/annuities Making your decision 25 Making your decision 11 It could pay to top up your pension Wish you’d paid more into your pension? If you can afford to top up your pension before you take your pension income, this may be to your advantage. Paying in extra money is not only tax-efficient, but it can help boost your pension income and you may be surprised at how a little amount can make a difference. Most pension companies will accept additional lump sums or contribution increases so it is well worth investigating. But before doing anything, make sure the pension income you would receive outweighs any charges you may have to pay to top up. The table opposite shows how paying into a pension has tax benefits* *This applies to personal and stakeholder pension only and not to occupational schemes. 26 Making your decision 0800 0121 167 Making your decision Your contribution You want to pay a gross contribution of Tax benefits You actually pay The taxman adds If you're a higher rate taxpayer, you can also claim back £800 £200 up to £200 £4,000 Basic rate tax relief is claimed from HM Revenue & Customs. In these examples basic rate tax relief £1000 is given at a rate of 20%. Higher rate tax payers can apply for up to an up to additional 20% tax relief when they fill in their £1000 self-assessment return. There is an annual allowance which applies to your contributions to all registered pension schemes. £1,000 £5,000 The allowance is £235,000 for the 2008/09 tax year. If your contributions exceed the annual allowance, there will be a tax charge of 40% on the excess contributions*. The Government has introduced an Annual Allowance. This applies to the value of your total pension contributions each year to all pension plans. The allowance is £235,000 for 2008/09 (increasing for at least the following 2 years). If the total of your pension contributions is in excess of this Annual Allowance you'll receive a special tax charge, called the Annual Allowance charge, of 40% on the excess amount. *Pension contributions made in the tax year in which you take all your benefits do not count towards the Annual Allowance. The above is based on our understanding, as at October 2008, of current taxation, legislation and HM Revenue & Customs practice, all of which are liable to change without notice. The impact of taxation (and any tax relief) depends on individual circumstances. www.pru.co.uk/annuities Making your decision 27 Taking action 12 What to do now Contact us for help and information about Prudential Annuities. Prudential representatives can only provide information on Prudential products. 28 Taking action 0800 0121 167 To contact us you can: > call 0800 0121 167*. Please quote A-Pockplan. > visit us 24 hours a day at www.pru.co.uk/annuities Existing Prudential customers can: > email us via PruMail – our secure email system – if you wish to contact us about an existing policy. Log on to pru.co.uk for more information. *Calls may be monitored or recorded for quality and security purposes. www.pru.co.uk/annuities Taking action 29 And finally Index of key terms Cancellation period See page 25 Company pension See page 16 Conventional annuity See page 18, 19, 20, 21 Defined Benefit or Final Salary Pension Scheme See page 6 Defined Contribution Scheme See page 6 Earmarked for division See page 23 Employee-benefits See page 14 Fixed (level) income See page 18 Increasing income See pages 19, 20, 21, 24 Joint life See page 24 Personal pension See pages 6, 26 Pension fund See pages 3, 6, 12 Pension income See pages 6, 11, 12, 14, 16, 18, 22, 24, 25, 26 Pension sharing (Pension splitting) See page 23 30 And finally 0800 0121 167 And finally Pension valuations See page 22 Retail Prices Index See page 19 Retirement age See pages 3, 6 Retirement fund See page 6 Retirement income See pages 10, 21 Single life See page 24 Stakeholder pension See page 26 State pension See pages 11, 16, 22 Tax-free cash lump sum See pages 12, 15 Topping up your pension See pages 26-27 Unit-Linked annuity See page 21 Income Choice Annuity See page 20 www.pru.co.uk/annuities And finally 31 www.pru.co.uk "Prudential" is a trading name of The Prudential Assurance Company Limited, which is registered in England and Wales. This name is also used by other companies within the Prudential Group, which between them provide a range of financial products including life assurance, pensions, savings and investment products. Registered Office at Laurence Pountney Hill, London EC4R 0HH. Registered number 15454. Authorised and regulated by the Financial Services Authority. PTPB6175 01/2009