For the last decade it has been more common for clients taking their pension benefits at retirement to opt to invest their pension in an Approved Retirement Fund (ARF), rather than to use the fund to purchase an income in retirement from a Life Company – known as an Annuity.
However, as interest rates have increased in recent years Annuities have become slightly better value for money.
It should be said that rates are still at relatively low levels, as the recent increases came off historical lows, but nonetheless an Annuity may be the retirement product of choice for some clients who might prioritise security of income over capital retention.
The full Contributory State Pension might be a useful reference point. Table 1 below illustrates the rates available for a 60 year’ old purchasing an Annuity, from three of the Irish Annuity providers.
A pension fund of c.€400,000 would be required to provide a matching (or slightly higher) private pension income equivalent to the State Pension. This assumes a tax-free lump sum of 25% of the fund value, leaving €300,000 to purchase the Annuity.
Table 1 below illustrates the rates available for a 60 year’ old purchasing an Annuity, from three of the Irish Annuity providers.
Table 1
Notes
- Rates shown are correct as at 8th July 2023.
- Level pension payments in retirement, no increases.
- Single life annuity, minimum payment period of 5 years.
Annuity Options
Once your have set up your annuity, the terms will be fixed for life. However, there are a number of different Annuities available, and the option you choose will impact the rate on offer, so advice is essential if you are considering an Annuity purchase.
Single Life/Joint Life Annuities.
An annuity can be purchased on a single life basis i.e. ceasing on the death of the individual, or on a joint life basis. Setting an Annuity up on a joint life basis will mean that some or all of the annuity can continue on to a second life (usually the spouse/civil partner), assuming they live longer than the main annuitant. The percentage of annuity transferring over to the second life is typically between 50% and 66%.
Minimum payment period.
Although not essential, most annuities come with a minimum payment period of 5 or 10 years. Even if the annuitant dies, after say only 3 years (in a Single Life Annuity), payments will continue to be paid into the estate of the deceased for a further 2 or 7 years respectively. In the case of annuities with a minimum payment period of less than 5 years a lump-sum may be paid by the insurance company in final-settlement**. The lump-sum will reflect the balance of payments due under the minimum payment period. If an annuity has no minimum payment period, the annuity ceases immediately upon death.
**Revenue do not allow this (lump-sum payment) feature on annuities offering a minimum payment period of more than 5 years.
Escalation.
Annuities can pay a flat level of income each month or they can pay an income that escalates in the course of payment by a fixed pre-selected percentage or by a percentage that’s linked to the Consumer Price Index (CPI).
Other Factors Affecting the Annuity Rate
The Provider.
As is evidenced by Table 1 above, rates will vary between providers. It is essentially to seek the advice of a firm with access to annuities from all of the major providers in the market, rather than simply accepting the rate offered by your own pension provider.
Your Age.
Simply put, the older you are, the better the rate you will be able to obtain. Some clients defer taking their pension benefits until age 70 or older, and the rates on offer will reflect the shorter expected payment period.
Your Health.
It might take some getting used to, but the worse your health is, the better the Annuity rate you might be able to obtain. With an ‘enhanced annuity’, your health and lifestyle health risks (for example smoking) are assessed in determining the level of pension income payable. Unlike with traditional insurance applications where medical conditions may go against you, with an Enhanced Annuity if you have an underlying medical condition (or some lifestyle factor such as smoking) this may give rise to an increase annuity rate offered.
Enhanced Annuities are can benefit people who suffer (or have suffered) from illnesses such as cancer, a heart condition or stroke.
Tax on Annuity Income
Income from an annuity is taxed in the same way as any other income, so the rate of tax and USC will depend on your individual circumstances and other sources of income in retirement.
Conclusion
If rates continue to rise, Annuities will become a real consideration for more clients. You can elect to invest in an ARF, purchase an Annuity, or both.
Both options involve an important set of decisions that may have far-reaching implications. Seek advice from a Financial Planner to ensure your hard earned pension fund is put to work appropriately.
For any retirement planning advice needed, contact Harvest at justask@harvestfinancial.ie or call us on 01-237 5500 and we will be delighted to assist.