Pension primer

Special report on how best to secure your financial future

CHOOSING the wrong pension for your retirement could see you lose out on several thousand euro — or more — in your golden years. This is because annuities — a pension which can be bought with the money in your pension pot when you retire — can offer very poor value for money. Many people are shocked at the tiny annual pension they can buy, should they opt for an annuity. An annuity might only pay you a pension of a thousand euro a year — or less, depending on the size of your pension pot.

You may not have to buy an annuity when you retire, however, and even if you decide to, there are steps you can take to boost the annual pension an annuity will pay you.

Many people don’t realise that they don’t have to buy an annuity from the company they’ve been saving their pension with — and so end up settling for a much smaller pension than had they shopped around. Indeed, earlier this year a Central Bank probe into the sale of annuities found that many companies were not clearly explaining to consumers that they have a right to shop around for these products.

You could lose out on €355 a year in pension income if you don’t shop around for an annuity — assuming you have €50,000 to buy one, according to the Central Bank probe. So failing to shop around could cost you €7,000 in lost income over your retirement — or more, if you live for longer than 20 years after you finish work.

HOW DO I SHOP AROUND?

When you buy an annuity, a life assurance company guarantees to pay you an annual income for the rest of your life. The higher the annuity rate you can get, the better — because it is this rate which ultimately determines the size of your annual income. You can work out the annual pension you’ll get by multiplying the annuity rate by the sum of money you are using to buy your annuity. For example, an annuity rate of 4pc would get you an annual pension of €4,000 if you have €100,000 to buy your annuity; a rate of 3pc would get you €3,000 a year.

The annuity rates offered by the various life assurers vary hugely, according to the recent Central Bank probe. So shop around to get the best rate. “From experience, we would typically see a spread [difference] of between 2 and 3 percentage points between the worst and best annuity rate that is being quoted,” says Mark Reilly, pension sales manager with Aviva.

When shopping around, be sure to compare like with like as there are different types of annuities.

With some annuities, your pension simply stops when you die — even if you pass away shortly after retiring. This means that you — and your dependants — could get very little back for all of the years you have been paying into a pension. So consider buying a guaranteed annuity if you have family. With a guaranteed annuity, your pension will continue to be paid to your estate for a certain amount of time (usually for either five or ten years) — even if you die shortly after buying your annuity. These annuities are more expensive than the ones which don’t come with a guarantee — but they offer peace of mind.

Another useful option if you have family is a joint-survivor annuity — which is often bought by married couples. With these annuities, a pension continues to be paid to the surviving partner when either you or your spouse dies.

It is worth finding out if you qualify for an enhanced annuity. An enhanced annuity could pay you a higher pension income than a standard annuity does — but you must have a history of ill health or an underlying medical condition to get one. An enhanced annuity could put an extra €100 a month into your pocket above the amount that a standard one does, depending on how severe your medical condition is and the size of the lump sum you have to buy an annuity.

For example, an enhanced annuity would pay a pension of €609 a month to a 60-year-old male with motor neurone disease — assuming the man had €187,500 to buy an annuity, according to James Skehan, head of pensions with New Ireland. A standard annuity, on the other hand, would only pay a pension of €500 a month.

Aviva, Irish Life and New Ireland are the main providers of enhanced annuities here.

ARE THERE ALTERNATIVES?

When interest rates are low — as they are now — it is expensive to buy annuities. Many people are eyeing up Approved Retirement Funds (ARFs) instead. An ARF is a personal retirement fund where you can keep your money invested after retirement, as a lump sum. You can withdraw money from your ARF regularly to give yourself an income when you retire.

One of the big advantages of ARFs is that any money remaining in your ARF after your death can be left to your next of kin. This isn’t always the case with annuities (unless you have bought a guaranteed or joint-survivor annuity).

IS AN ANNUITY OR ARF BEST FOR ME?

Be sure to weigh up the pros and cons of annuities and ARFs before deciding which one to choose.

“They key difference with ARFs is that you’re in charge,” explains Jerry Moriarty, ceo of the Irish Association of Pension Funds (IAPF). “Depending on how you invest the money in your fund, it can continue to grow — though it will obviously deplete as you draw down income. The theory with ARFs is that with a reasonable level of ongoing fund growth, you’ll have more money in retirement — however, unlike the annuity option, you’re taking all the risk.”

One of the disadvantage of ARFs is that you don’t know how long you’ll live for — and so how long the money in your ARF must last. It is therefore difficult to decide how much of an income you can afford to take out of your ARF each year. Your ARF could run out of money if you take too much out of it each year — or if you live a particularly long life.

An ARF may be more suitable for you than an annuity if you are willing to take on investment risk in your retirement years, according to Moriarty.

Should you be uncomfortable with investment risk, however, an annuity is probably your best bet.

“Annuities offer certainty and security as they will be paid for life,” says Moriarty. “Most people in retirement want predictable, steady income for life and that is what an annuity will give you.”

Remember, it is as important to shop around for an ARF as it is for an annuity.

“It is important to understand the charges being applied to your ARF and how it is being invested,” says Moriarty.

Either way, the decision to buy an annuity or ARF should not be taken lightly — so do your homework and be sure to make the best use of the money in your pension pot.