Is an Annuity a good investment?

At Heritage Wealth, we appreciate that deciding what to do with your pension fund is one of the most important financial decisions you will have to make. There are various options available to you and now is a good time to seek professional advice, to ensure that whatever decisions you make are best suited to support you financially in the many years of retirement ahead.

One of these retirement options may involve the purchase of an annuity. This article explains in clear terms what an annuity is and how it works for many pensioners.

Firstly, what exactly is an Annuity?

An annuity is a financial product sold by insurers that pays out an income to an individual for the rest of their lives. An annuity is the only product that ensures a secured income for life. For this reason, annuities will especially appeal to individuals who want a solid, safe form of investment, free from risk, that will provide certainty of income in retirement.

Most people will generally only come across annuities at retirement age. Most retirement plans operate by accumulating a fund of money on behalf of an individual over the period of their working life. By the time the person reaches retirement the pension fund will have achieved a certain value. This value (also, referred to as the ‘capital sum’) depends very much on the level of contributions that have been paid into the retirement plan over the individual’s years of service. The higher the level of contribution, the larger the fund, although other factors like investment returns will also have a bearing on values.

Are Annuities a reliable financial product?

Unlike some investment products, annuities are not invested in stocks and shares and therefore they not subject to the same type of volatile market fluctuations that these assets are exposed to. The attraction of annuities is that they offer consistency of income over the lifetime of the person. Market volatility may come and go but an income from an annuity is paid regardless of investment conditions.

How do I know what rate of income I will receive?

When a person reaches retirement, they will have accumulated a fund of money. Let’s suppose the fund of money equals €200,000 and out of that amount the person takes a tax free lump sum of €50,000 (this is subject to certain qualifying conditions). They then can use the balance to purchase an annuity. The insurance company accepts the €150,000, agrees the yield / price based on annuity rates (say, 3%) at that time, and the insurer will then provide an income of €4,500 (150,000 x 3%) for life to that person (the ‘annuitant’) for as long as they live. If the annuitant passes away after 6 years for example, and assuming it was a single life annuity, the funds stay with the life company and the annuitant’s beneficiaries do not receive any funds from the life company.

However, the pensioner (annuitant) may also consider purchasing a joint life annuity, whereby 50% of the annuity continues to the second life (for example, a spouse) for their lifetime and ceases on their death. It is important to note that the annuity rate (annual yield, 3% in the previous example) reduces when you add in a 50% spouses pension (joint life annuity), and may decrease even further if you add a further benefit like escalation, whereby the yield / payment grows each year to counteract the negative effects of inflation.

What type of Annuity can you purchase?

  • Single / Joint Life Annuity – 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 where some or all the annuity can continue to a second life (usually the spouse/civil partner), assuming they live longer than the main annuitant;
  • Enhanced Annuity – An enhanced annuity is a product where the income provided is based on your health circumstances. The company providing your annuity assess your health through a lifestyle and medical questionnaire completed as part of the annuity quotation process. If you qualify for an enhanced annuity, the income provided will be higher than that provided under a standard annuity;
  • Standard Annuity – A standard annuity product does not take account of your health circumstances in setting the income level. The standard annuity will be an option if you do not qualify for an enhanced annuity.

In summary, upon retirement it is vital that you weigh up and the pros and cons of each option available to you. The current flexible pension environment has given people more choice in how they spend their retirement savings, and active investing in the global stock markets will make sense for many people. However, not everyone will want to experience the volatility associated with the stock markets. We maintain that you should always take professional financial advice on how to make the most of your retirement savings.

Gerard O’Brien LL.B LL.M CFP® QFA is a Certified Financial Planner and the Owner of Heritage Wealth Management, a Financial Planning practice based at 27 Cook Street, Cork. For more information, contact Gerard at gerard@heritagewealth.ie www.heritagewealth.ie

Disclaimer: All data and information provided within this article is for informational purposes only. Heritage Wealth Management Limited makes no representations as to accuracy, completeness, suitability, or validity of any information and will not be liable for any errors, omissions or delays in this information or any losses, injuries, or damages arising from its use.