Pension providers manage investments on behalf of their clients who are saving for their retirement. When an individual client's retirement date arrives, then a way needs to be found to convert the accumulated value of the savings (the pension fund) into a regular income for the remainder of the client's life. This is done through a pension annuity. Simply, the savings in the pension fund are used to purchase an annuity.



Buying an annuity

Although the purchase of an annuity is therefore very simple in principle, a surprising number of people give it little thought and instead make the first purchase they are offered – which in most cases is going to be the annuity offered by the pension provider with whom they have been saving. Even though many annuities bought directly from the provider in this way represent relatively poor value for money, it has been estimated that as many as two-thirds of those starting their retirement purchase their annuity in this way – many could have used their accumulated pension investment to buy an annuity on the open market that would have significantly increased their income every one of their retirement years.

What makes the choice of an annuity such an important purchase, however, is not just this difference in the returns from different annuities, but the fact that the purchase is a once-in-a-lifetime purchase. Once it has been bought, the consumer cannot simply switch to another annuity provider that appears to be offering a better return. Indeed, once bought, the annuity cannot be changed in any way for the remainder of the consumer's life. When the capital accumulated in the pension fund has been used to purchase an annuity, there is no way of channelling any of it back to a surviving beneficiary on the death of the annuity holder.

The importance of independent financial advice

Because it is such a one-off decision, it can be readily appreciated why sound, independent financial advice should be sought for the purchase of an annuity. As if the unique nature of the purchase is not enough, however, there is such an array of different annuity types that independent financial advice becomes doubly critical.

If you are married, for example, you will wish to consider whether to use your pension fund to buy a single or a joint annuity – the latter providing a pension for your spouse in the event of your death. With either a single or joint annuity, you could also decide to take an element of financial risk in the annuity you receive – rather than elect a guaranteed, fixed annuity – by choosing a "with profits" annuity that adds future bonuses to your annuity income, depending on the performance of the annuity company's investment fund.

If a fixed retirement income is your guiding objective, a standard level annuity is likely to be your choice. If you are concerned about the annuity keeping pace with inflation, however, then you are more likely to opt for an annuity that increases in line with the retail prices index or an annuity that has an in-built, year on year fixed rate of escalation.

The choices are many, varied and all the time diversifying still further. An independent financial adviser, qualified in pensions matters, therefore, is the best placed professional to advise you on your pension annuity purchase.