Get more money from your pension

If the time has come to turn your pension pot into an income, where will you get the best value for money?

When the time comes to hang up your boots and finally clock out for the very last time, you’ll be thinking about taking benefits from your pension. Most people use an annuity to convert their pot into a regular income which is guaranteed to pay out for the rest of their life.

Sounds simple enough, doesn’t it? But the trouble is buying the right annuity isn’t quite as easy as it seems. And, to make matters worse, annuity rates have recently hit an all-time low.

Why are annuity rates so important?

The prevailing annuity rates when you come to retire will determine how much income you can squeeze out of your pension. Back in the nineties annuity rates were set at about 14%. That meant a pension pot worth say, £100,000 could generate an annual fixed income of £14,000 (100,000 x 14%). Nowadays, even the best annuity rates would yield an income of less than half this amount.

Of course, there are several factors which affect the changes in annuity rates, but much of the blame for the current historic low has been laid at the doorstep of falling gilt yields. Annuity companies tend to invest heavily in gilts to back annuity payouts, so when yields drop dramatically - as they are doing now - this will only have a negative impact on today’s annuity rates.

So it’s pretty clear that you need to hunt down the best possible annuity you can to maximise the income you can draw from your pension. But how do you go about doing that?

The open market option

As you drawer closer to your retirement date, your pension company will most likely send you a quote for the level of income they are prepared to pay you based on the value of your pension pot (among other factors). But you should pay very close attention to the annuity rate they are offering you as this will be used to convert your pot into a set level of income.

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This is known as using the Open Market Option or OMO and it’s just a fancy way of saying you’ll compare the market before choosing the most competitive annuity. And you’ll be really glad you did because the gap between the best and worst annuity rates can be huge. Choose a poor rate and you’ll be stuck with a lower income for the rest of your life.

The table below shows which annuity companies are currently offering the highest rates based on a pension pot worth £100,000. Note that these annuities provide a fixed income for the rest of your life, and are guaranteed to pay out to you and or your estate for a minimum of five years regardless of whether you survive that long or not. These annuities are for a single life only and provide no benefits for your spouse or partner.

Top 5 standard annuity rates (based on a £100K pension pot)

Rates shown are for a level annuity which is guaranteed for five years and pays no spouse’s benefits.

As you can see, the most competitive standard annuity at the moment is offered by Hodge Lifetime. A £100,000 pension pot could provide a 65-year old man with an annual income of £6,540. Meanwhile, a woman of the same age would get £6,130 each year. (Annuity rates are lower for women because they are expected to live for longer.)

The lowest annuity rate for a man age 65 would provide an income of just £5,530 (from AXA) which means living off £1,010 less every single year compared with the top rate from Hodge Lifetime. So, you can see there’s an awful lot to be gained for the simple task of shopping around.  

Just bear in mind that annuity companies generally change rates on a reasonably regular basis. The companies topping the best buy tables today may not always offer the top rates tomorrow.

Get even better annuity rates

The rates shown above are for standard annuities designed for healthy people who are expected to survive to reach average life expectancy. But if you’re life expectancy is lower than average, you may be able to take advantage of a more generous type of annuity. Where an annuity is expected to pay out for a shorter period of time, you will be compensated with higher annuity rates.

For example, if you smoke, you should check the rates for special smoker annuities. The table below shows the top three rates for both men and women age 65.

Top 3 smoker annuity rates (based on a £100K pension pot)

Rates shown are for a level annuity which is guaranteed for five years and pays no spouse’s benefits.

You can see these rates are significantly higher than the standard annuity rates shown in the first table. The income for a male age 65 from the top annuity company - Reliance Mutual - will provide an extra annual income of £890 compared with the most competitive standard annuity from Hodge Lifetime.

In a similar way if you suffer from a medical condition such as diabetes or high blood pressure, you may be able to benefit from an uplift using what's known as an enhanced annuity. Check out the table below to find out how much extra you could gain:

Top 3 enhanced annuity rates (based on a £100K pension pot)

Rates shown are for a level annuity which is guaranteed for five years and pays no spouse’s benefits.

More: Great news for your pension! | Boost your pension income by 20% a year