The 'devil' of personal finance

I'm Fergus Muirhead and I'm here to answer any questions you may have about any money or consumer issues.

Please drop me a line at with your questions. You can also read more on money and consumer issues on my own blog.

One of the most popular subjects for questions from viewers and listeners is the annuity.

I suggested in an earlier answer to a question that "pensions" were the devil of personal finance. Well, I was wrong. Pensions are the devil's apprentice. The devil is the annuity!

An annuity is defined in the Oxford Dictionary as "an investment of money entitling an investor to a series of annual lump sums".

What does that really mean?

Buying an annuity

Well, let's say you've been investing in a personal pension for a number of years and you've built up a fund of £100,000.

When you "buy an annuity" with that money, you give your cash to an insurance company and in return they will provide you with an income for the rest of your life.

It could also be for a guaranteed minimum number of years, which means that your spouse or children will continue to get your income if you're unfortunate enough to die soon after purchase.

Now you might have been reading that annuity rates are at "an all-time low" at the moment.

There are a number of reasons for that. Partly it's because we're living longer and partly it's because the markets in which annuity money is invested have been a bit unstable recently.

But the net result is that your pension fund will produce less per pound now than at any time in the recent past - although that may have changed by the time you read this since the rates are fluid and change on an almost day-to-day basis.

And that's why it's important if you are about to buy an annuity that you understand the ramifications of doing so, and you take the time to look into the options available to you.

Retirement date

The insurance company, or companies if you have more than one, that you have been using to build up your pension fund will be very quick to write to you as your "normal retirement date" approaches.

What this date should be is the subject of another article, but from a legal point of view it is usually anywhere between your 55th and 75th birthdays.

It will be the date that you nominally told your insurance company that you wanted to receive your pension when you set it up sometime in the dim and distant past.

The letter will explain your options and will major on the benefits of using your pension fund to purchase an annuity from them. The options will generally include taking up to 25% of the fund you have built up as a tax-free cash sum on the date you have nominated and then to purchase an annuity with the remaining 75%.

As mentioned above, that annuity can either die with you or can be paid out to dependents after your death, with the result that any initial income you receive is likely to be less since the payment may have to be made for a longer period of time.

You don't have to take tax-free cash when you retire but most people choose to do so, partly because it will come in handy and partly because the income that you receive with the other 75% is potentially taxable, depending on your overall tax position.

Considering options

How you decide to use your pension fund at retirement will be dependent on your personal situation and there is no right or wrong answer, but you do need to consider the options available very carefully because decisions can't generally be reversed, and once you have purchased an annuity that will be the end of your fund.

As well as considering the options available from the insurance company writing to you, it's important to remember that you don't have to buy your annuity from them at all.

Somewhere in the literature you receive from your insurance company you will read these three words - "open market option". They won't be in large print and they won't be prominent because what they mean is that you can hawk your fund round the market to and sell it the company that offers you the biggest income.

And this is really important. Not every company calculates its annuity rates in the same way and there can be a big difference between the highest and lowest figures on the market. So you really do have to shop around.

So make sure you do! Don't just take what you are offered. There may well be better deals out there and it's worth spending the time trying to find them.

It's also possible to use your pension fund to provide an income while still retaining control of the money that is in it, and next time we'll look at how that works, and who might benefit from this type of arrangement.

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