Read this article to find out why you should be very careful when the time comes to take an income from your pension.
Rumours of yet another pensions mis-selling scandal are becoming increasingly audible. This time the trouble centres on taking your pension benefits at retirement.
The OMO
Many of you may not realise that when you buy an annuity - which converts your pension pot into a regular income stream - you don't have to take the first deal you're offered by your pension provider. Instead, you have the right to shop around, compare annuity rates from a whole range of companies and choose the most generous one to boost your income.
This is known as using the 'open market option' or OMO. But according to data from the Association of British Insurers, fewer pension savers are taking advantage it. In fact, less than one in four buy a better annuity on the open market than the one offered by their existing pension company. Worse still, it would appear some pensions providers aren't doing as much as they should to make sure we know we could get a more competitive deal elsewhere.
So I hope industry watchdog, the Financial Services Authority will step up its work in this area to nip this mis-selling scandal in the bud. But in the meantime here's how to make sure you don't get caught out.
Annuity rates
It's more important than ever to squeeze as much money as you can out of your pension pot. That's because annuity rates have begun to drop, having peaked last year.
For a while annuities enjoyed a bit of a boost in the financial crisis and, back in May, I explained why the credit crunch was good for your pension. In fact, during 2007, annuity rates rose by more than 6% as a knock on effect of the squeeze on credit. But, unfortunately, the lift in rates turned out to be pretty short-lived, as I later pointed out why falling interest rates are bad for your pension.
According to lovemoney.com partner Moneyfacts, average annuities rates have already fallen near on 5% since the beginning of December. And this could be the start of a very unwelcome trend. So it's vital to shop around for the very best annuity you can find.
The figures below demonstrate the difference in the level of income you could be living off in retirement when you compare the best annuity with the worst:
Shopping around for annuity rates
|
|
Male |
|
|
|
Female |
|
|
|
| Ages |
60 |
65 |
70 |
75 |
60 |
65 |
70 |
75 |
|
Highest rate |
£3,315 |
£3,663 |
£4,152 |
£4,908 |
£3,135 |
£3,424 |
£3,829 |
£4,426 |
|
Lowest rate |
£2,763 |
£3,049 |
£3,455 |
£4,050 |
£2,636 |
£2,899 |
£3,278 |
£3,847 |
|
Potential uplift |
20.0% |
20.1% |
20.2% |
21.2% |
18.9% |
18.1% |
16.8% |
15.1% |
The results speak for themselves. Take the example of a man age 60 with a pension pot of £50,000: If he was unfortunate enough to choose the worst annuity provider he would get an annual income of £2,763. This is equivalent to an annuity rate of just 5.52%.
But by opting for the most competitive provider instead, he would boost his income by a massive 20% to £3,315 - which equals a much higher annuity rate of 6.63%. That means an extra £552 in income every year guaranteed for the rest of his life just because he shopped around for the most competitive rate at the crucial moment.
And it's a similar picture for women and older pension savers across the board too.
How do you use the OMO?
As you approach retirement, your pension company will send you a retirement pack which outlines the amount of income they are prepared to pay you from your pension pot. Then all you need to do is compare the rate you've been given with the rest of the market. If you're not confident doing this yourself, a qualified financial adviser can help you, but there's normally a fee of around 1% of your pension fund for this advice.
On the other hand, if you're happy to go for it yourself there are a number of websites which can compare rates for you such as the annuity supermarket from www.annuity-bureau.co.uk. Or you can take a look at the latest best buys from pension provider and adviser, Hargreaves Lansdown. Alternatively, you can use the Money Made Clear website from the Financial Services Authority.
Once you've found the best deal make sure you act quickly because annuity rates can be changed at any time.
Don't forget, you may be lucky enough to have your pension with a company that also happens to be an annuity market leader. In which case, there's nothing to stop you staying where you are if the first rate you're offered is competitive.
Enhanced annuities
The rates shown in the table above relate to a standard annuity for a pension saver who is in good health and expected to live to average life expectancy. But the actual annuity rate you'll be offered will depend on your own personal circumstances. This not only includes how old you are, your gender and sometimes where you live, but some specialist annuity providers will also look at your health.
If you have health problems you may be able to go one step further by applying for an 'enhanced' or 'impaired life' annuity. Even people who smoke can qualify for increased annuity rates. These special annuities can provide an even greater uplift to your income. Find out more here.
For more tips take a look at how to buy the right annuity.
More: Five things to do before you retire | New pension plan is more good than bad