From responses so far there seems to be some confusion as to how pensions work, so here's a very simplified guide.
Step 1 - paying for your pension.
You pay contributions into your pension fund. This might be a pension scheme provided by your employer (in which case you don't have a choice of where or how the money gets invested), or could be a private pension that you have set up for yourself (e.g. a stakeholder pension). If it is a company scheme then your employer may add an extra contribution over and above what you pay. What you pay comes out of taxed income, so when the pension company gets your monthly contribution they claim back from HMRC the tax that you paid and this gets added to your fund.
The pension company will invest your monthly contributions in a mix of things: equities (shares), bonds, loans, government stocks, cash, property, investment trusts, and many more). Some will be high risk and some low risk investments. In the early years a higher proportion will be invested in higher risk, and as you get closer to your chosen retirement age they switch the funds into lower risk investments to preserve the fund value.
The pension companies that provide this service are experts in investing and that is their real strength.
Step 2 - at retirement age
When you first join a pension scheme, or set up your own pension, you will be asked what age you expect to retire at. You can change your mind about what age you actually retire at later, but the pension companies must have a guideline to work to because there are legal requirements they must follow when you get close to the age you have given them. Firstly they must remind you when you are in your last year before retirement age, and then remind you again 6 weeks before the retirement date.
They will tell you how much pension you would be paid if you were to buy your annuity from them. By law they must advise you that you do not have to take your pension from them, but you have what is called an Open Market Option. This allows you to shop around to see if you can get a better annuity rate from another company. If you do decide to buy the annuity from somewhere else then your pension company is not allowed to charge you or make any deduction for transferring the fund elsewhere.
Pension companies don’t want to lose your business, which they know they will do if you shop around and see just what a poor deal they are offering. So most pension companies do one of two things - they include the open market option details in such small print and buried amongst all the other legal bits they have to explain that you are unlikely to notice it; or they word it using so much technical jargon that you wouldn't have a clue what they are talking about and would be unlikely to understand its significance. And it is extremely significant. The rate they quote you is never their "best" rate. But they don't tell you that it's negotiable and at least 60% of people don't shop around. They simply sign the acceptance form that comes with the advice pack. Even a person in perfect health who shops around would be likely to get 10% better elsewhere. The pensions companies rely on our inertia, and that is what pays them huge profits.
The same applies if you are in a company scheme (provided it is not a final salary scheme - because you can't improve on them). You don't have to take your annuity from the pension company that has been looking after your fund, even though it is the "preferred" company of your employer. You are just as entitled to shop around, and if you have diabetes then you really should shop around because no pension company is prepared to match the enhanced annuities that the specialist annuity companies offer.
You will often see tables of annuity rates published in the financial sections of the press. If you look at these you will see that, even on a standard annuity for a healthy person there can be a big difference between what the highest and lowest will pay. Sometimes you will see tables for smokers and these pay out higher rates than the healthy ones - because a smoker is likely to have a lower life expectancy. What the papers don't publish is rates for enhanced or impaired annuities because there is no set rate - each has to be individually calculated depending on your own circumstances.
So what exactly is an annuity?
This is what you use your pension fund to buy. You are not allowed to just cash in your fund and walk off with the cash. In exchange for that pension fund your annuity provider will pay you an income for the rest of your life. The income can be paid at a flat rate (what you are paid never changes), or it can increase annually, can be paid to a dependent after your death, and many other combinations. What type of income or protection you opt for will dictate how much gets paid each month. Generally if you opt for a “joint life” annuity (where your spouse will continue to be paid after you die), then the annuity would be about half what would be paid if it was only in your name.
Once you have made your choice, you can never change this. Whatever you choose is for the remainder of your life, so it had better be the right choice.
What happens when I die?
If you die before you have bought an annuity, then the money in your pension fund is returned and forms part of your estate. If you have taken an annuity that will continue to pay a dependent after your death then your dependent will continue to be paid. If the annuity is in your name only then whatever has not been paid out is the annuity company’s profit. You could have a pension fund of £50,000, hand it over to buy an annuity, get the first months payment, and then die. The annuity company has made a nice fat profit from you. In many respects it’s the opposite of life insurance. You could take out an insurance policy and peg it a month later and the insurer loses out. With an annuity, if you die too soon then you lose out and the insurer profits.
Where someone has a significantly shortened life expectancy, then there is another option to taking an annuity. This is to leave the fund where it is and to take from the fund what is called “income drawdown”. There are legal limits on how much can be drawn in this way, but it ensures that whatever remains undrawn in the fund can be inherited if you die. Unfortunately you can only take income drawdown up to age 75. It is a very useful tool for anyone who expects to not reach 75, but it is not widely advertised, and this is an area on which it is important to get expert advice. So you would need to discuss it with an IFA.
Where does an IFA come into this?
As I mentioned in an earlier post, the specialist annuity companies that offer much higher pensions to diabetics do not deal with the public. They only operate through IFAs, and this is because it is very important that you should take expert advice on which type of annuity (or income drawdown) would be best in your individual circumstances, particularly where those circumstances are your medical history.
How do you find a good IFA if you don’t already have one?
Well, you can do the cheeky thing and go into a local building society (not a bank under any circumstances) and ask who they would recommend – they always know the best ones in your area. Or you could ask a friend, relative or work colleague if they know of an IFA they would recommend. Alternatively do the research yourself. Have a look at one of the “find an IFA” websites, like
http://www.unbiased.co.uk
http://www.searchifa.co.uk
http://www.ifa-guide.co.uk
These all have a search by postcode facility so that you can get a list of the IFAs in your locality. Have a look at their websites before you speak to them. You will find that some are specialists in pensions business, whereas others are specialists in other things like investment planning or insurance. You will soon see which ones are the pensions specialists. Make a short list and phone them or pay them a visit.
How much will this cost me?
Nearly all IFAs will not charge for a first consultation, and generally one meeting is all you will need! If an IFA wants to charge you up front, than don’t use them. IFAs make their money from the commission that is paid to them by the annuity companies, so you don’t have to pay anything to the IFA. Ah, but won’t that mean they will only offer me the one that pays them the most? Actually the commission paid by the annuity providers is pretty standard, so they don’t personally gain by recommending one over another. In addition these days IFAs are probably the most heavily regulated industry there is and they have a code of conduct that ensures that in every case they can only recommend what is best for you. As well as that, they want you to feel that you have had a fantastic service and to recommend them to your friends and colleagues.
I have tried to cover as many questions as I think you might come up with, but I’m sure I will have missed a few. Please don’t be afraid to ask me if there is anything you don’t understand. I am very happy to help, but as I said right at the very beginning, I will not advise you on which pension is right for you. I can only advise you who you should speak to to get that expert advice.
Step 1 - paying for your pension.
You pay contributions into your pension fund. This might be a pension scheme provided by your employer (in which case you don't have a choice of where or how the money gets invested), or could be a private pension that you have set up for yourself (e.g. a stakeholder pension). If it is a company scheme then your employer may add an extra contribution over and above what you pay. What you pay comes out of taxed income, so when the pension company gets your monthly contribution they claim back from HMRC the tax that you paid and this gets added to your fund.
The pension company will invest your monthly contributions in a mix of things: equities (shares), bonds, loans, government stocks, cash, property, investment trusts, and many more). Some will be high risk and some low risk investments. In the early years a higher proportion will be invested in higher risk, and as you get closer to your chosen retirement age they switch the funds into lower risk investments to preserve the fund value.
The pension companies that provide this service are experts in investing and that is their real strength.
Step 2 - at retirement age
When you first join a pension scheme, or set up your own pension, you will be asked what age you expect to retire at. You can change your mind about what age you actually retire at later, but the pension companies must have a guideline to work to because there are legal requirements they must follow when you get close to the age you have given them. Firstly they must remind you when you are in your last year before retirement age, and then remind you again 6 weeks before the retirement date.
They will tell you how much pension you would be paid if you were to buy your annuity from them. By law they must advise you that you do not have to take your pension from them, but you have what is called an Open Market Option. This allows you to shop around to see if you can get a better annuity rate from another company. If you do decide to buy the annuity from somewhere else then your pension company is not allowed to charge you or make any deduction for transferring the fund elsewhere.
Pension companies don’t want to lose your business, which they know they will do if you shop around and see just what a poor deal they are offering. So most pension companies do one of two things - they include the open market option details in such small print and buried amongst all the other legal bits they have to explain that you are unlikely to notice it; or they word it using so much technical jargon that you wouldn't have a clue what they are talking about and would be unlikely to understand its significance. And it is extremely significant. The rate they quote you is never their "best" rate. But they don't tell you that it's negotiable and at least 60% of people don't shop around. They simply sign the acceptance form that comes with the advice pack. Even a person in perfect health who shops around would be likely to get 10% better elsewhere. The pensions companies rely on our inertia, and that is what pays them huge profits.
The same applies if you are in a company scheme (provided it is not a final salary scheme - because you can't improve on them). You don't have to take your annuity from the pension company that has been looking after your fund, even though it is the "preferred" company of your employer. You are just as entitled to shop around, and if you have diabetes then you really should shop around because no pension company is prepared to match the enhanced annuities that the specialist annuity companies offer.
You will often see tables of annuity rates published in the financial sections of the press. If you look at these you will see that, even on a standard annuity for a healthy person there can be a big difference between what the highest and lowest will pay. Sometimes you will see tables for smokers and these pay out higher rates than the healthy ones - because a smoker is likely to have a lower life expectancy. What the papers don't publish is rates for enhanced or impaired annuities because there is no set rate - each has to be individually calculated depending on your own circumstances.
So what exactly is an annuity?
This is what you use your pension fund to buy. You are not allowed to just cash in your fund and walk off with the cash. In exchange for that pension fund your annuity provider will pay you an income for the rest of your life. The income can be paid at a flat rate (what you are paid never changes), or it can increase annually, can be paid to a dependent after your death, and many other combinations. What type of income or protection you opt for will dictate how much gets paid each month. Generally if you opt for a “joint life” annuity (where your spouse will continue to be paid after you die), then the annuity would be about half what would be paid if it was only in your name.
Once you have made your choice, you can never change this. Whatever you choose is for the remainder of your life, so it had better be the right choice.
What happens when I die?
If you die before you have bought an annuity, then the money in your pension fund is returned and forms part of your estate. If you have taken an annuity that will continue to pay a dependent after your death then your dependent will continue to be paid. If the annuity is in your name only then whatever has not been paid out is the annuity company’s profit. You could have a pension fund of £50,000, hand it over to buy an annuity, get the first months payment, and then die. The annuity company has made a nice fat profit from you. In many respects it’s the opposite of life insurance. You could take out an insurance policy and peg it a month later and the insurer loses out. With an annuity, if you die too soon then you lose out and the insurer profits.
Where someone has a significantly shortened life expectancy, then there is another option to taking an annuity. This is to leave the fund where it is and to take from the fund what is called “income drawdown”. There are legal limits on how much can be drawn in this way, but it ensures that whatever remains undrawn in the fund can be inherited if you die. Unfortunately you can only take income drawdown up to age 75. It is a very useful tool for anyone who expects to not reach 75, but it is not widely advertised, and this is an area on which it is important to get expert advice. So you would need to discuss it with an IFA.
Where does an IFA come into this?
As I mentioned in an earlier post, the specialist annuity companies that offer much higher pensions to diabetics do not deal with the public. They only operate through IFAs, and this is because it is very important that you should take expert advice on which type of annuity (or income drawdown) would be best in your individual circumstances, particularly where those circumstances are your medical history.
How do you find a good IFA if you don’t already have one?
Well, you can do the cheeky thing and go into a local building society (not a bank under any circumstances) and ask who they would recommend – they always know the best ones in your area. Or you could ask a friend, relative or work colleague if they know of an IFA they would recommend. Alternatively do the research yourself. Have a look at one of the “find an IFA” websites, like
http://www.unbiased.co.uk
http://www.searchifa.co.uk
http://www.ifa-guide.co.uk
These all have a search by postcode facility so that you can get a list of the IFAs in your locality. Have a look at their websites before you speak to them. You will find that some are specialists in pensions business, whereas others are specialists in other things like investment planning or insurance. You will soon see which ones are the pensions specialists. Make a short list and phone them or pay them a visit.
How much will this cost me?
Nearly all IFAs will not charge for a first consultation, and generally one meeting is all you will need! If an IFA wants to charge you up front, than don’t use them. IFAs make their money from the commission that is paid to them by the annuity companies, so you don’t have to pay anything to the IFA. Ah, but won’t that mean they will only offer me the one that pays them the most? Actually the commission paid by the annuity providers is pretty standard, so they don’t personally gain by recommending one over another. In addition these days IFAs are probably the most heavily regulated industry there is and they have a code of conduct that ensures that in every case they can only recommend what is best for you. As well as that, they want you to feel that you have had a fantastic service and to recommend them to your friends and colleagues.
I have tried to cover as many questions as I think you might come up with, but I’m sure I will have missed a few. Please don’t be afraid to ask me if there is anything you don’t understand. I am very happy to help, but as I said right at the very beginning, I will not advise you on which pension is right for you. I can only advise you who you should speak to to get that expert advice.
