Personal finance – Making the most of your pension fund

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Harold from Ickworth sent me an enquiry about pension annuities this week, writes Nick Plumb.

He wrote: “I read in the newspaper that the Financial Services Authority are looking at the issue of Annuity Purchase and people not taking up an Open Market Option when they retire. What is the Open Market Option and why are the FSA concerned about it?

Before answering Harold’s question, it is important to understand exactly what an annuity is, as many people I speak to are not sure where annuities fit into the ‘retirement picture’. In the UK, the words ‘pension’ and ‘annuity’ are often interchanged, but they don’t actually mean the same thing.

When you save money for retirement you will put it into a pension. That can be a company pension scheme or a personal pension. If you have a personal pension or a ‘money purchase’ company scheme, when you retire, you will usually need to buy an annuity with your accumulated fund. An annuity is an income for life that is purchased from an annuity provider or insurance company, using your pension fund. It can be purchased with the entire pension fund or it can be from the funds remaining after a tax-free cash lump sum has been taken. If you take the tax-free cash option, the maximum you can take is 25% of the fund value. The remainder buys the annuity.

So, when you hear someone say ‘I’m 82 and I’m getting a pension paid every month’ what they really mean is that they are 82 and they are getting an annuity paid every month. It’s a bit like saying you are ‘running the Hoover round, when you are actually using a Dyson.

You can choose to have your annuity income paid on a level or escalating basis, to have a spouse’s or widow’s pension paid after your death, and you can even build in a guarantee period ensuring that the full amount would continue to be paid to your spouse or estate if you died within that guarantee period. However, there is a cost to all these ‘bells and whistles’ and any features added to the annuity will reduce the amount you receive at outset.

The Open Market Option

Contrary to popular belief, you do not have to buy your annuity from the same company that you have saved into a pension with. You therefore need to establish whether your annuity should be purchased from the company you already have your pension fund with, or whether you should transfer your funds to another company and buy your annuity from them.

This is called exercising your Open Market Option.

It is quite common to find that the company your pension is with may not have the best annuity rate. If you ask your Independent Financial Adviser to investigate this for you, you could find that the rate you can get elsewhere could be up to 30% more than that offered by your existing pension provider.

This is what the FSA are looking into, because some companies do not make it clear that you have this choice, or they make it easier to just sign their forms and send them back. In many cases, that can mean that the annuity you receive will be lower than you could have obtained elsewhere.

Enhanced and Impaired 
Life Annuities

There is an added benefit of ‘shopping around’ for a better annuity rate if you suffer any form of ill-health. If you have a serious medical condition, you may be entitled to an Impaired Life Annuity because of your state of health and reduced life expectancy. Even if you suffer from conditions controlled by medication and diet, like high blood pressure or diabetes, or if you are a smoker, you may be entitled to an enhanced annuity that is considerably higher than the standard annuity rate.

It has been estimated by a leading provider of enhanced and impaired annuities that 40% of pension annuitants could benefit from these higher rates, but currently only 4% actually do so. Most people just don’t realise that this option is available to them, and they simply accept what is offered by their existing pension provider.

At Plumb Financial Services, our ‘At Retirement’ specialist, Beverley Baxter, will research the entire annuity marketplace to find our clients the best possible annuity rate. Beverley regularly obtains annuity uplifts of over 20% when compared to the rates offered by an existing pension provider. If you are just coming up to retirement, it could pay you to take independent advice on your own annuity purchase options before you commit to accepting what might be a lower income for the rest of your life.

- Nick Plumb is an Independent Financial Adviser and Practice Principal at Plumb Financial Services. Post your questions to Nick at Plumb Financial Services, Baylham Business Centre, Lower Street, Baylham, Suffolk, IP6 8JP, e-mail, or telephone Nick on 01473 830301. Nick’s opinions and views in this column are provided only as a general guide and do not constitute personal financial advice. Any readers who require advice should contact Nick to arrange a complimentary initial consultation to discuss their own position and requirements. Plumb Financial Services is regulated by the Financial Services Authority.