A guiding hand needed through pension maze

After years of building up a pension fund, it’s vital to ensure that you make the most of that money to maintain the lifestyle you are accustomed to and fulfil retirement dreams.

The range of choices is considerable, the jargon often complex and number of under-performing insurers still worrying. It’s a good time to enlist an independent financial adviser, who will probably not cost a penny as they will be remunerated by the chosen provider.

To find an IFA close to your home or work, contact www.unbiased.co.uk. Ask about their experience and qualifications in this field. The Pensions Advisory Service may also prove useful as an independent organisation that can answer pension and annuity questions (0845 6012923).

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To trace any pension you have lost track of, contact the Pension Tracing Service (0845 6002537).

Prior to making a decision on a personal pension (or its pre-1988 predecessor, the oddly named ‘retirement annuity contract’), it may be helpful to know how much can be expected of a state pension. The Future Pension Centre will provide a free forecast (0845 3000169) whilst The Pension Service gives information about deferring a state pension (0845 6060265).

Most choose a lifetime annuity which converts a pension fund into taxable pension income which is paid for the rest of your life. It’s a vital decision that cannot later be altered. Yet far too many take the easy route of accepting their current pension provider’s offer of a regular stream of money. It should always be checked and could mean you receive over 20 per cent more income.

The pension provider should make contact prior to the age you have selected to retire with the value of the fund and their offer of an annuity.

Pre-retirement, make four choices:

n Decide to buy or defer taking a pension income for life;

n Select the most appropriate option, such as for a single life, or to protect a spouse/partner, inflation-protected and other alternatives;

n If a tax-free lump sum up to 25 per cent of the pension fund value is preferred to a higher annuity;

n Choose the best provider, taking health and lifestyle into account.

It’s a myth to think that buying an annuity means work has to stop. You can continue in full or part-time employment. However, income from an annuity is subject to tax at your personal rate. It’s also possible to delay taking an annuity but ask the pension provider if they have any charges for postponement.

The whole pension fund or funds can be taken in cash if the value is not more than £18,000. Otherwise the usual arrangement is to buy an annuity.

Decide if the annuity is for yourself or jointly with your spouse/partner and if the latter whether the regular payment on your death will be the same amount or a lower rate, such as 50 per cent. Opting for a joint one will reduce the value.

Then select either a flat rate for life or one which starts lower but increases by a fixed rate (typically three or five per cent) or according to an index (consumer prices or retail prices). If there is no protection, the annuity loses its true value through inflation but it can take two decades before the difference with a flat rate payment catches up.

A further variation is to have a guarantee that the annuity will be paid for a set number of years so that in the event of premature death, payment will continue to the estate. The usual terms offered are five and ten years from the time the annuity started.

A variation is the ‘capital protected’ annuity which pays a lump sum equivalent to the amount paid less any income received. It is subject to both income tax and inheritance tax charges.

Far too many retirees do not realise they may qualify for an ‘enhanced’ or ‘impaired’ annuity which pays a higher income because they are a smoker, overweight, have high cholesterol or are in poor health.

One in seven annuity buyers received an enhanced quote last year but Stephen Lowe at specialist providers Just Retirement in Reigate calculates two in three would qualify.

As more realise they qualify, this sector is rising rapidly, up 22 per cent in 2011 in 12 months.

Annuity providers differ in the factors they take into account. Some use occupational ratings whilst postcodes are now also coming in as actuaries know mortality is higher in some districts than others.

Once the basis of the annuity sought has been made, compare alternative quotes, known as the ‘open market option’. Some providers will only act through an adviser. Check if the pension policy comes with guaranteed rates. Older policies often gave such certainty but the rate is likely to be personal and not apply to a joint life annuity. Aviva will not increase its guarantee if the person has enhanced annuity factors.

Those with large pension funds (often £250,000 plus) and prepared to accept some investment risk – rather than rely on corporate bond and gilt yields – have alternative routes:

n Stock market investment-linked annuity;

n Capped drawdown where an income up to a prescribed limit is taken from a pension fund;

n Flexible drawdown where unlimited sums can be withdrawn from a pension fund provided other income sources are available;

n Phased retirement where the pension fund is divided and annuities are purchased on different dates.

Plans are also available which provide a regular income with guarantees either of investment growth or the lump sum remaining to buy a later annuity.

The decision on when to take an annuity can be postponed until 75 which should allow the pension pot to grow further. However, annuity rates have been falling like a stone, partly through rising longevity rates but largely because providers are making poor investment decisions.

Another downside to postponing is that the pension fund may impose a ‘market value reduction’ as it had planned the money would be taken on a specified date. There is no excuse for this as it should ring fence your funds at that point.

To show the difference between key providers, a £100,000 purchase of a joint life annuity (male 65, female 60) would pay £5,229 annually (Canada Life), £5,082 (Aviva), £5,051 (Legal & General), £4,475 (Prudential) but only £4,271 (Scottish Equitable), according to advisers Hargreaves Lansdown.