Maximising Your Retirement Income: Are Pension Annuities The Answer?

Your retirement savings are the difference between being able to live comfortably and having to make difficult decisions about how you spend your money. So, deciding how you manage your pensions is critical to anyone's retirement wealth game plan. Pension annuities can guarantee a steady retirement income for life - but are they the best way to utilise your retirement savings? And are they the best method of pension drawdown for expats? In this blog, we'll cover what exactly pension annuities are, how they're calculated, the benefits and risks and whether annuities might be the right (or wrong) choice for your retirement income.

Why would you need a pension annuity?

pension annuity

After you retire and begin drawing down on your pension fund, you can usually take an initial lump sum at a specific age; the balance is then used to provide regular income.

Many pensions aren’t actually designed to supply you with an income during retirement. A pension is essentially an investment vehicle that you and/or your employer contribute to in order to grow capital.

On retirement so that you can convert this lump sum to income, you need a tool that enables this. Annuities are historically the go-to tool. With modern pensions, however, it’s no longer compulsory to purchase an annuity and there are alternatives. But more on that later!

What exactly is an annuity?

A pension annuity is basically a type of insurance plan. It’s a way to secure an income for life by exchanging all of your pension savings into a lifetime contract that guarantees an income for the rest of your life. They’re typically bought from life insurance and pension companies and there are many different types that offer different rates of income.

Usually, annuity income stops when the owner dies. However, there are some options that allow for some of the income or a portion of the remaining fund to be paid to a beneficiary.

How does a pension annuity work and how are they calculated?

Annuity rates depend on multiple factors. There are certain market influences that might impact the value of your annuity – like interest rates.

The income level will generally be presented as a percentage of your pension pot – for example, an annuity rate of 5% on a pension of 500,000 will provide an income of 25,000 per year.

So, say you lived for 20 years after purchasing the annuity. That means you’d have drawn down an income that matches the total value of your pension pot at the time of purchasing the annuity. If you lived for longer, you’d draw down more than the original value. If you live for less than 20 years, you’d have an unutilised amount of your original pension pot.

When you purchase an annuity, your health and circumstances will be taken into consideration. Generally, this means if your life expectancy is lower you can expect a higher rate of income. This is because the product provider will expect to pay the income for a shorter period of time, with a lower overall payout.

What are the benefits of annuities?

The main benefit of purchasing an annuity is that it will provide you with a regular income for the rest of your life. This kind of consistency makes it easier to know what to expect in retirement and plan for your lifestyle.

This makes annuities a good idea if you want peace of mind or have worries about your money running out in retirement.

What are the different types of annuities?

There are many subtypes of annuities, but most can be broken down into two main types – fixed pension annuities and variable annuities. A top-level explanation is as follows:

Fixed annuities – Fixed annuities are just what they sound like – an annuity that’s fixed. This means that the payout amount is guaranteed, which can help you plan for your retirement income.

Variable annuities – Variable annuities are a type of life insurance policy that allows you to invest your money. There are no guarantees about the payout amount. And, it’s possible that you could lose some or all of your investment. However, a “rider” can be purchased to lock in a guaranteed income stream regardless of performance, like a hedge against market losses.

Drawbacks of annuities

Usually, a pension annuity lasts only as long as you do. If you live a very long life, you might end up with a great deal. However, if you die not only would you have lost out on making the most of your retirement pot beforehand, you might not leave any of it behind either. That’s because your spouse might then not get any of that income – or just a small part of it.

Additionally, there are usually high initial fees for purchasing an annuity. Different annuity types come with different costs. Typically, these include premiums, commissions, admin fees and surrender charges. Generally, the complex the annuity product the higher the costs are for you.

Also, there’s a lack of flexibility. If you found that you need access to a higher income during retirement for whatever reason, there’s no way to change the amount paid out by your annuity. Therefore, you lose control of your funds with no strategy for emergencies.

You would also lose control of your funds in terms of how they’re invested. If you don’t purchase a pension annuity on retirement, you can potentially continue to grow your capital by using investment strategies.

Many see annuities as a “safer” investment option. It’s possible to shop around and get better offers and higher income payouts with different providers. But, ultimately, when purchasing an annuity you’re banking on a presumed reality of what your retirement will look like and your lifespan. In reality, things could be very different.

When is it best to use an annuity?

pension annuities for expats

If you have health problems, trying to get an enhanced pension annuity could maximise your income in the short term.

With annuities, a medical condition can work in your favour and substantially boost the amount of money you could receive.

So, if you encounter ill health or find yourself facing a life-changing event that could affect your income, an annuity could definitely be the right choice for you.

Pension annuities are also an attractive option if you have a limited amount of money and want the security of knowing that it will be there for you in retirement.

What are other forms of pension drawdown for expats?

Depending on your pension scheme, you may have alternative drawdown options available to you other than annuities. Instead, you may be able to select another option, such as a drawdown plan or flexi-access drawdown. As well as being able to access your funds early, these schemes allow you to take out more than one lump sum from your pension pot.

Depending on your tax residency status, domicile and taxation rules and the particulars of your pension plan, this may be more attractive than buying an annuity.

Each pension scheme will have its own rules regarding how much you can withdraw and how often. With some, purchasing a pension annuity will be compulsory. Others, like International SIPPs will offer flexible drawdown options. In some cases, you can take out as much money as you want.  In others, there are restrictions on the amount of benefits that you can withdraw each year or for a set period of time.

The tax implications of pension drawdown will differ for each individual depending on where you live and your earnings.

Get expert international financial advice before making any decisions on pension annuities

expert international financial advice

If you have a pension plan, understanding the calculations involved in determining its benefits is really important. It’s also critical to understand the tax implications of using them. Getting unbiased advice is even more critical when it comes to pension annuities and other pension drawdown options for expats.

Get help deciding whether an annuity or alternative pension drawdown method is best for you. Make sound financial decisions with our expert financial advice for expats by clicking here to contact us.