With retirement steadily approaching, some people might assume that they will automatically get an income from their pension from day one, and they need not do anything before the big day. But it is up to an individual as to how they turn a pension fund into their regular income for their twilight years. This is done by buying a pension annuity, which essentially involves swapping your lump pension fund for a plan which will provide you with consistent payments on which to live on.
Choosing the correct pension annuity which suits your needs is extremely important. This is because in most cases annuities are fixed and cannot be changed once they have been purchased. Someone will typically not be able to simply switch to a new product five or six years after retiring. An annuity is normally irreversible, and therefore making the right decision is crucial.
Basic rules mean someone can take retirement benefits aged 50 at the earliest. This is set to rise to aged 55 in 2010. Many people opt for a lifetime pension annuity, designed to supply them with a consistent cash flow for the rest of their days. This is not the only thing on the table, but is normally irreversible once you have chosen it.
Different levels of annuity are available, with some providing virtually zero risk in return for a steady and safe amount of money. Some are linked to investments, and carry varying degrees of chance, meaning someone can end up with a very healthy income in the long run or could end up getting far less than they expected. The nature of investing part of your pension in this way means returns go up as well as down.
Some people might assume that they will have to stay with whoever has administered their pension while they were working when it comes to sorting out an annuity. This is not the case, as what is known as the open market option gives people the entitlement to look at other deals and rates from other annuity providers. The annuity offered to you by your pension provider may not always be the best value, so shopping around for other products can be beneficial.
The law also says that someone who has created a pension fund must swap it for an annuity before they turn 75. The logic behind an annuity works by estimating how long someone will live and using this as a guide for the regular cash sum it will pay you. Someone does not have to buy an annuity if they retire before they are 75, and they can hold off the decision for as long as they like until 75 at the latest.
What is known as a conventional annuity is one of the most common types, and does not involve investment risk. This means irrespective of what happens in things like stock markets, or with regards to house prices, the person will still get their income. This type of annuity is also not connected to mortality risks, and you will still get a payment even if you live for a very long time.
There are also things like enhanced and impaired annuities, which offer more money than a conventional annuity and can be taken up by people with significant medical conditions. An investment pension annuity can come in many different forms, at different levels of risk, and an independent financial adviser can help someone decide what is best for them in the long run.
Steve Wright is Managing Director of http://www.YourPensionAnnuity.com an independent financial adviser specialising in retirement advice and pension annuity.