What On Earth is an Annuity?
Posted on: 29 April 2013 by Rupert Drummond
Are you struggling to make sense of annuities? Then stop what you're doing, make yourself a cuppa, and read this post!
Put simply, an annuity is a private pension. You cough up the money during your working life and you get it back later when you are of more mature years and pays a guaranteed income for life. Although this may be the basic principle of an annuity, there are differences between the annuities that are on offer, and ideally one has to shop around to find the one that is best suited to them.
At retirement, most workers will have accumulated a sum of money known as a pension pot. This is the money that will be used to by their annuity or their fixed and negotiated yearly sum for the rest of their lives. At the present time you would have to live until you were 83 years old to start making money on top of what you put in your annuity when you were 65 years old. The more years that you live beyond 83 years, the more you make on your annuity deal. If you were to die when you are 73, financially you would lose. Taking out an annuity is a gamble, as the annuity companies prop up their losses on those who live longer with money taken from those who die early. It is a little bit reminiscent of a bookmaker who hedges his bets!
Before diving headlong into an annuity plan one should consider several options, all of which have their own pros and cons.
1. Take your tax- free pension pot cash and buy your annuity.
2. Do not take the tax-free cash and still buy an annuity
3. Take the tax-free cash now but buy the annuity later on.
4. Invest in a fixed term or investment linked annuity.
The three ‘golden rules’ when purchasing an annuity
1. The buyer should have other forms of income to fall back on if the annuity falls in value.
2. All relevant risks should be well understood when buying an annuity.
3. Investors should have considered the four options listed above.
It would be hard to believe in this current economic climate that investment returns could get much worse. Rock bottom must be considered to be the point at where you can only get out exactly what you put in. Sometimes taking a risk is a less ‘risky’ thing to do. Likewise, it is no considered so ‘smart’ to put all your eggs in one basket.
If you are capable of working for another two years or so beyond retirement age this can prove to be financially beneficial during your retirement.
The interest rates paid on annuity investments are linked directly to gilts or government bonds and presently these are near an all-time low. As we saw in the recent Cyprus banking scandal, two weeks before investors and savers in Cypriot banks had there cash raided those in authority had told them that their money was safe. Many ecumenicists are warning that the fragile economic climate and ‘unethical’ banking systems are going to get worse before it gets better, and if you only get out what you put in then you might as well keep it in a safe or under the mattress.