Lots of people save part of their income through occupational and personal pension schemes. Most schemes of this nature are money purchase schemes, which means that on retirement the money invested in the fund will be converted to cash, which is used to buy an annuity. At this point there are many different options which the person may consider, including level and escalating incomes, and joint life or single life policies. This article reviews some options that are available. People can use an annuity calculator to estimate the effect of the different options on the amount of income which they will receive in retirement.
Although some people are members of defined benefit schemes, of which final salary schemes are the best known example, most other schemes come into the category of money purchase schemes. An employed person, and also their employer in the case of an occupational scheme, make contributions into the pension fund, which is invested so as to build up as large a pension pot as possible by the person’s retirement date.
When a person retires the pension fund will be cashed in, and is often used to buy an annuity. These are sold by life assurance companies, who undertake to provide a lifetime income, regardless of how many years the pensioner lives for after their retirement date. This system has the benefit of protecting people from the dangers of exhausting the funds in their pension pot.
The following types of pension are normally cashed in to buy an annuity: stakeholder and personal pensions, Additional Voluntary Contributions (AVC), Freestanding AVCs, and retirement annuity contracts. Members of occupational money purchase schemes may sometimes buy the annuity themselves, but in some cases it will be bought for them by the fund managers.
There are numerous different kinds of lifetime annuity, which allow retired people to choose something suitable to their personal circumstances. One of the most basic choices to be made is between a single and a joint life policy. Single life policies do not provide an income for a partner if the pensioner predeceases that person. These are therefore more suitable for single people, or if the partner has their own pension.
There is also a choice between a level and an escalating policy. Escalating policies can be either linked to the RPI, or can increase at some fixed rate, for example 3%.
A third option which may be considered involves a guaranteed payment period. Annuities aim to provide a guaranteed lifetime income, and are therefore poor value if the pensioner were to die at an early age. With a guaranteed period of payment, which is typically five or 10 years, the income would continue to be paid, either to the person’s spouse or partner, or into their estate.
The amount of retirement income depends both on the value of the pension fund, and on the options chosen when purchasing the annuity. Those who wish to estimate the effect of the many different options on the amount of retirement income which they would receive, can use a simple online annuity calculator tool.