Retirement Options Explained – Part 1 of 3 – Annuity

In the past, when you got to retirement age, it used to be very simple. You got a cheque and then you started to receive an amount into your bank account every month instead of your salary. Now, you can either:

  1. Purchase an annuity
  2. Invest in an Approved Retirement Fund
  3. Take it all as taxable cash

Over the next 3 weeks, I am going to explain what each of these options are and the pros and cons of each, so you have a bit more information when it comes to making what is a very important decision (you should also seek financial advice). I will also discuss the tax free cash along the way. Today we are going to start with the traditional annuity.

What is an annuity?

An annuity is where you give an insurance company your pension money and in return they promise to pay you an agreed amount for the rest of your life. You can choose different features of the annuity such as:

  • Single life or joint life annuity
  • Indexed linked or flat annuity
  • If a joint life annuity is chosen, what percentage of your pension does your spouse get on your death? 50%? 100%?

These decisions must be made when the annuity is being purchased and cannot be changed at a later date.

How much do I get?

That depends on a number of factors:

  1. The choices made at outset. For example, a single life, flat annuity for a 65 male with €500,000, will get an annual annuity of €25,092 for the rest of his life. A 65 year old with the same amount with an indexed linked annuity at 3% each year and a spouse’s pension of 100% of his own will only get €13,352 in year one (it will increase at 3% per annum but after 35 years, would still not have paid out as much as the single life, flat annuity).
  2. Age. The older you are, the shorter the life company thinks they will have to pay out for, so the better the rate you get.
  3. Medium and long term interest rates. Life companies tend to invest in long term bonds to meet their pay out. If rates are low, so are annuity rates.

Tax-Free Lump sum

If you have a personal pension plan, your tax-free lump sum is 25% of the value of the fund and you may buy an annuity with the remainder.

Things are slightly different for people in company paid schemes. If you want an annuity, you must take the 150% of final salary lump sum option. Getting 150% of final salary as a tax free lump sum is dependent on having the required number of years service.

Finally, I leave you with the pros and cons of the annuity options.

The Pros

The Cons

You get a secure, regular income for life so you know exactly where you stand.

Once you take the pension, your income level is fixed or indexed to an agreed amount per year and can’t be changed afterwards.

You can choose an annuity type that best suits your needs, such as one that gives a part-pension to your dependants after you die and/or inflation linked.

If you choose a level pension, or one that does not increase each year, inflation will reduce its value during your retirement.

Once you invest in an annuity, you will not need any more investment advice in relation to it.

The annuity rate is fixed the day that you buy the annuity, so you won’t benefit from any later increase in annuity rates.

You don’t need to worry about investment risk as your income is guaranteed.

If you die early and your annuity income is just for your own lifetime, the money you used to buy the annuity does not go to your dependants. Basically, your annuity dies with you.

You pay lower charges than with an Approved Retirement Fund (ARF).