What is an annuity?
Last week we wrote an article outlining what an Approved Retirement Fund (ARF) is.
You can read that here.
Based on feedback received, we have decided this week to continue with the retirement planning theme.
Therefore, we are going to outline what the alternative to an ARF is.
When you reach retirement, you have choices with your pension fund.
Firstly, your tax-efficient retirement lump sum (an element of which will be tax-free).
Then, invest in an ARF or purchase an annuity.
As per last weeks article, these also apply if you want to draw your pension early.
You can read here about the comparison of one versus the other.
Below, we’re going to focus on the annuity.
What is an annuity?
And how does it work?
What is an Annuity?
In its simplest form, an annuity is a product that pays you a fixed income.
Guaranteed to be payable for life.
After you withdraw your lump sum from your pension, you use the balance to purchase an annuity.
In return, your annuity will pay you a fixed income.
The income can be monthly, quarterly, half-yearly or annually.
How does an Annuity work?
After you withdraw your tax-efficient lump sum from your pension, you have a balance of your fund remaining.
We go to the open market and find out who will pay you the highest income for your chosen annuity structure.
You then give the annuity provider your pension fund and in return, they will pay you your income.
Very much like a transaction in a shop.
But, in this instance, you give them money, they give you a regular income.
What income can you take from your Annuity?
The annuity provider will calculate the income.
There are a number of contributing factors to this.
Firstly, what annuity structure do you want?
Do you want to build in a pension for your spouse or civil partner?
What about your pension increasing every year?
Some of the influencing factors are:
- Your age
- Are you married or single?
- Your health status
- Do you want it to increase each year
- The current interest rate environment
How frequently can the income be distributed?
Most annuity holders take the income monthly.
However, if it’s really low, I see some taking it annually.
Quarterly and half-yearly are also income frequency options.
Is Annuity income taxable?
Yes.
Annuity income is assessable for income tax, USC and PRSI.
Is an Annuity invested anywhere?
No.
There is no investment risk with an annuity.
Investment markets do not affect the income.
The income is guaranteed.
Simply as there is no underlying investment.
What Annuity structures are there?
An individual can set up an annuity with some variables.
Spouses Pension
Does an annuity holder want to include a pension for their spouse?
We will assume yes.
Consequently, from the date of the annuity holders death, the annuity will pay the surviving spouse some level of income.
At outset, the spouse’s income is set.
This is usually 50% or 100% of the annuity holders pension.
Note, the higher the spouse’s income %, the more expensive the annuity becomes.
Guarantee Period
An annuity will pay a guaranteed income for the holders’ life.
A ‘Guarantee Period’, will help to protect the income, to some degree, against the holder passing away early.
For example, an annuity with a ‘5 year guarantee period’.
We will assume the holder passes away within the first 5 years of the income commencing.
The full pension of the annuity holder will pay till the 5th anniversary of the commencement date of the annuity.
Importantly, this is to the 5th anniversary of the commencement date of the annuity, not the 5th anniversary of the death.
If the annuity holder lives longer than the guarantee period, the guarantee period becomes redundant.
Consequently, the longer the guarantee period chosen, the more expensive the annuity becomes.
Inflation Protection
The holder can set the income to increase annually.
The indexation rate is normally 2%, increasing annually.
It should be noted, if indexation is chosen, the initial annuity amount on offer is significantly reduced.
Treatment of an Annuity on death
On death, the annuity dies with the annuity holder.
Where a spouse / civil partner pension is included at outset, it is different.
Subsequently, in this instance, the spouse’s pension commences from the date of the annuity holders death.
It will then pay for the lifetime of the spouse / civil partner and cease on their death.
Advantages of an Annuity
- Income is certain – X amount per month / annum for the remainder of the holders life
- No investment risk
- Longevity risk – very good if the holder lives long
Disadvantages of an Annuity
- No more access to the capital – when purchased, it cannot be reversed
- No flexibility – when set up, it cannot be changed
- Longevity risk – if you don’t live long, the capital is lost
- Inflation – long term inflation will over time erode the purchasing power of n annuity that is level in payment
- Currently poor annuity rates due to the current low-interest rate environment
- Provider default risk
Is there a requirement for ongoing advice?
No.
When set up, there is no need for ongoing advice.
Not in respect of the annuity at least.
Separately, a consumer may require alternative financial planning advice.
But specifically to the annuity, no.
Discuss Your Retirement Options
Summary
To summarise, an annuity is a relatively simple product.
You purchase it, it pays you.
The requirements of the holder dictate the structure of the income.
There are flexible options with spouse’s pension, guarantee period and inflation protection.
Above all, with all aspects of financial advice, the most important thing is an individual takes the proper advice.
Advice on the best retirement option for them and the best way to structure their income.
How We Help
At Fortitude Financial Planning, we review clients’ retirement options.
Importantly, we factor in our clients’ circumstances to our recommendations.
Their individual circumstances, their need for guaranteed income, their tolerance for any investment risk.
Consequently, this ensures there is logic, reasoning and math behind any of our recommendations.
If an annuity is the recommended option, we structure it to suit our client.
We will show figures with and without spouses pension, with and without guarantee periods and with and without inflation protection.
We are not a tied agent and have access to all providers.
This means that our clients get the highest income payable to them for their chosen annuity.
Have you received your pension retirement options?
Or are you looking to access your pension before Normal Retirement Age (NRA)?
Do you want to compare the ARF option against the annuity?
Get in touch
Take the first steps to work through your annuity and ARF options and learning what they will be and request a callback.
You can also drop me an email, francis@fortitudefp.ie give me a call, 086 0080 756 or even access our diary here and book a call at your convenience.
We are happy to have a no obligation chat with you initially.
This allows us to assess if we can help and bring value to you.
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