Boost your pension payout
Going shopping for an annuity is vital if you want to maximise income, writes Teresa Hunter.
PRICES are rising fastest for pensioners, according to research by Clerical Medical, which found that the cost of the goods and services they use rose by 36% in the past decade, compared with a 32% climb in the Retail Prices Index.
The Joseph Rowntree Foundation said a pensioner couple needed 201 per week, excluding housing costs. The sharp jump in council tax and the costs associated with maintaining a property have hit the elderly particularly hard.
It goes without saying, then, that shopping around for the best annuity is vital for maximising income in retirement.
Yet one third of retirees accept the first quotation that their existing pension company offers. Of the two-thirds who do shop around, half still stay with their existing company, says the Association of British Insurers.
Scottish Widows head of commercial management Alison Morris says: "It is not always possible to switch to a new company, as insurers are looking for biggish pots. Most companies have a minimum pension (with) annuities of 5,000 or 10,000, and it can be even higher when it comes to an enhanced annuity, for health grounds."
Before you begin shopping around, ask yourself a few key questions. Which annuity will offer the best value? Will you need to protect against inflation? How good is your health? How long do you expect to live?
Protecting against inflation
A level annuity pays out a set amount every year, and these rates have risen steadily over the past three years because bond yields, on which they are based, have been rising.
One consequence of the credit crunch is that the market now demands a higher yield before investing in corporate bonds, which insurance companies buy to back level annuities.
However, level annuities leave pensioners vulnerable to inflation. If inflation runs at 3%, then after 25 years the purchasing power of a level income has fallen by more than half.
One option is to buy an annuity that increases by a fixed amount each year. This will give you less to begin with, but will not slash your starting income to the same extent as one that is fully linked with inflation.
Fixed-increase annuities are also largely backed by level corporate bonds, even though the annuity providers are having to meet a rising liability. Annuity providers manage the mismatch between assets (level-income corporate bonds) and liabilities (an increasing income) through interest rate swaps.
The point is: fixed-increase annuities have followed the level annuity rates upwards over the past three years, unlike index-linked contracts, which have fallen by 4%. For this reason, Hargreaves Lansdown claims that fixed-increase annuities are better value than RPI-linked ones, mainly because the latter are backed by Government index-linked securities, or gilts. These are in limited supply and rely largely on Government-issued debt.
Demand for RPI-linked gilts is sustained by institutional investors who need to match their inflation-linked liabilities with appropriate investment assets. With the threat of inflation looking more serious than at any time in the past 10 years, the market is charging quite a premium for inflation-proofing. As a result, the yield on index-linked gilts and annuities has been dropping, even while the yield on conventional bonds was rising.
Nigel Callaghan, Hargreaves Lansdown pensions analyst, says: "Protecting your income from the ravages of inflation is as vital as ever. However, we feel that if you are going to buy an annuity, then a fixed increasing annuity at 3% is likely to be a much better deal than RPI linking.
"Whatever form of income you end up drawing from your pension, make sure you always shop around first."
Impaired health annuities
It is possible to improve your pension further by opting for an impaired health annuity which, unlike almost any other kind of insurance, rewards customers for poor health and bad behaviour by paying them bigger pensions.
If a customer smokes, is overweight or suffers from high blood pressure or cholesterol, they could enjoy up to 25% extra through an enhanced annuity. And if they have had more serious illnesses such as heart disease, cancer or multiple sclerosis, their income in retirement could more than double.
According to Annuity Direct, the retirement income specialists, pensioners are forgoing 60m annually, which adds up to nearly 1bn wasted in retirement, by not exploring enhanced or impaired annuities.
These contracts were launched little more than 20 years ago. At first the market grew slowly, with contracts offered by a few specialist companies such as Just Retirement, Partnership Assurance and Tomorrow (formerly GE Life). However, recently activity has exploded, with giants such as the Prudential, Norwich Union and Scottish Widows writing business.
Each company will have its own definitions and ratings for health conditions. As a general rule, enhanced annuities cover what are considered minor conditions such as smoking, diabetes, high blood pressure and cholesterol, and being overweight. Applications are rated on a points score card, and the more boxes you tick, the more pension you get. Smokers might get 8% more than they would from a standard annuity. If they are also diabetic, that could rise to 12%, and so on.
However, if they have a history of more serious and complex health problems such as heart disease, cancer, dementia, Parkinson's or motor neurone disease, the company will ask for a doctor's report. These customers are then underwritten individually.
Retirees are strongly advised to always get quotes from companies that would offer them an annuity. Origen, Bank of Scotland Annuity Service, Hargreaves Lansdown, Annuity Direct and the Annuity Bureau have departments specialising in this area. For example, one Origen customer with a 206,000 pension fund was offered an annual 18,020 from his own company. When quotes were sought from the impaired specialists, because of a history of heart disease, Norwich Union offered 34,296. Tomorrow was next at 22,689, then Partnership Assurance quoted 20,410, Legal & General 22,744, Just Retirement 21,509, Scottish Widows 22,398 and Prudential 21,839.
Stuart Bayliss, of Annuity Direct, confirms that the gap between companies can be enormous. "I recently had a 63-year-old female client with high blood pressure who had a breast cancer episode in April 2004. She had a 30,000 pension pot, for which her own company had offered her 1,850 annuity.
"That time Scottish Widows was the best deal, offering 2,470 annual income, which was 620 a year more than the existing company. But what surprised me most was that this was also 374 more than the next best quote from Just Retirement, of 2,096."
Sometimes the gap is even more eye-watering. Tomorrow offered a 74-year-old man with 56,000 savings – who had diabetes, had lost sight in one eye and had high cholesterol – nearly 1,500 more than the next best deals from Prudential and Just Retirement, boosting his pension by a quarter.
It pays to look for a higher offer
WHEN it came to sorting out his pension, Eric Vallance wasn't taking any chances, writes Teresa Hunter.
The Glasgow purchasing manager had various bits of pension gathered over a long career, but his two biggest pots came from long stints at an engineering firm and a marine leisure equipment provider."
I bought my house 30 years ago, and when I think about what I paid for that, it was tiny compared with what I was about to spend on an annuity."
Nevertheless, when it came to retirement, Eric's pots were not big enough to provide the kind of pension he had hoped for. He shopped around, and the best deal seemed to be with Norwich Union.
But after NU gave him his original quote he heard about impaired life annuities and asked for another quote, taking his medical record into account.
"I have always been very healthy and fit, and played competitive tennis for 50 years, but unfortunately things went a bit wrong for me in 1996 when I had a slight stroke and cancer of the bladder."
After taking this into consideration, NU boosted its offer by nearly 7%.
Eric, 65, said: "It is absolutely crucial that people realise the importance of shopping around for the best annuity, and that they do have options. They should never accept the first offer they are made."
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