Is there a better place than an annuity to put a pension pot?

If I do end up buying an annuity, is there a chance that the new government will make changes to the age by which you have to buy an annuity?

SM, Inverness

A If the annuity is purchased from funds accrued within a pension scheme, all of the income produced is taxed as earned income. However, if you purchase an annuity from your own funds, a portion of the income produced is deemed to be a return of your capital outlay and is not taxable. Pension annuities cannot be purchased until age 55.

In simple terms, an annuity is an income stream paid for by a lump sum. Annuities can provide income to the purchaser only, or can include a spouse/civil partner or dependant's pension, payable on death.

The income itself can be level or escalating and is determined by the annuity rate on the date of purchase. Annuity rates take into account the life expectancy, sex and health of the annuitant and the shape of the annuity being purchased. They also depend on interest rates or, more specifically, gilt yields.

Historically, once you bought an annuity you were locked into it and could not alter the type you have chosen or switch to a different provider. However, there has been some innovation in the market and temporary annuities are now available.

You can also purchase annuities in stages, using tranches of your pension fund. This phasing of retirement benefits allows an income to be part-secured without locking in your entire fund at the first instance.

There are other ways in which to draw an income from your pension, namely unsecured pensions and alternatively secured pensions.

An unsecured pension (USP) is available for those aged between 55 and 75, with the income drawn directly from the funds invested in line with parameters set by the Government Actuary's Department (GAD). This allows a decision on purchasing an annuity to be delayed and provides potential for lump-sum death benefits to be provided if death occurs before age 75. However, this option is normally deemed suitable for more sophisticated investors with higher levels of pension fund, as there are risks that investment returns will be insufficient to cover the income being drawn and the pension fund itself becomes depleted, leaving an individual worse off that if they had purchased an annuity at outset.

The government has said it will end the rules requiring compulsory annuitisation at 75. However, there is already another option at 75, in the form of an Alternatively Secured Pension (ASP). This allows you to draw an income from the pension fund as an alternative to purchasing an annuity. However, the maximum income you could draw would be less than USP, and there is an 82 per cent tax rate applicable to ASP funds on death.

As you can see, there is no requirement for you to purchase an annuity immediately upon retirement and, depending on your personal circumstances, it may be beneficial not to do so. Retirement funding is a complex area and one where you must seek independent financial advice.

Christian Poziemski is a wealth manager in the private client and financial services division of HBJ Gateley Wareing.

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This above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and HBJ Gateley Wareing accept no liability on the basis of this article.