Avoid this £9,000 loss to your pension income

When it comes to buying an annuity, delays could cost you money. Here's how to make the process run smoothly.

Deciding how to take benefits from your pension isn’t an easy decision. Most of you will probably buy an annuity which converts the lump sum in your pension fund into an income. But once you’ve bought an annuity you’re locked into that decision for the rest of your life, so it’s crucial you get it right.

The Open Market Option (OMO)

In this article I’m going to look at using the Open Market Option (OMO). In other words that means shopping around for the best annuity. On top of choosing the right annuity company, you’ll also need to decide on the right type of annuity for you. For more help on this, have a read of How to buy the right annuity.

But let’s get back to the OMO. Shopping around is one of the best things you can do to ensure you’re getting the best value for your pension money. This is because each annuity company sets its own annuity rates and it’s these rates which influence how high -- or low -- your income in retirement will be.

Let’s say Company A offers you an annuity rate of 7%. If you had a pension pot worth £100,000 this annuity would provide you with an annual income of £7,000. However, if you went to Company B where your annuity rate is just 6%, you would only receive £6,000. So, by choosing Company A over Company B you would be £1,000 better off every year for the rest of your life.

That’s why it’s so important to find the most competitive rate because the difference between the best and the worst can be staggering. You can buy an annuity through a good independent financial adviser or you can try an online service such as www.annuitybureau.co.uk or www.annuitydirect.co.uk who will compare the market for you. You can also compare annuity rates on the FSA's consumer website Money Made Clear.

Many people make the mistake of sticking with their original pension company to pay out their annuity. But if the rates they offer are low, you will lose out. Of course, you may be lucky enough to have your pension with a company that also offers generous annuity rates. If so, then it’s fine to stay where you are.

Annuity delays

But finding the best annuity rate is just the beginning. The process of moving your pension fund from your original pension provider to a new annuity company can sometimes drag on. In fact, a review of annuity transfers carried out by the Financial Services Authority (FSA)found that six out of ten transfers suffered delays.   

This is not good. Not only is a delay frustrating, but it could also reduce the amount of income you eventually receive for two reasons:

1. Lost time equals lost income - The longer you have to wait for your pension to be converted into an annuity, the more income you’ll miss out on in the meantime. If it takes three months to complete the process, you would have missed out on three month’s worth of income. 

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So based on the most competitive annuity available today -- which will turn a pension pot of £100,000 into a monthly income of £588* -- you would suffer a total loss of almost £2,000.

2. Annuity rates might drop during the transfer period - You will be given an annuity quote at the beginning of the process which provides an estimate of the amount of income you’ll receive. But this isn’t set in stone until the annuity is set up. 

Let’s say the rate for the particular annuity you have chosen drops by 0.5% during the transfer period. Using the same example as above, this would force your annuity income down from £588 a month to just £558.60. Now imagine your annuity pays out for the next 20 years. This monthly reduction would lead to a total loss over that 20 year period of more than £7,000.

How can you avoid these losses to your pension income?

Some annuity companies have a pretty good turnaround for setting up annuities so the process may well run smoothly. But follow these tips to minimise any hold ups:

A minimum of four months before the date you chose to take benefits from your pension scheme, your pension provider will send you a ‘Wake Up’ letter outlining all your options including your right to use the Open Market Option. Let your pension company know what you want to do as soon as possible. If you want to shop around, ask for quotes straightaway. It should only take a few days to get a quote back from an annuity company.

It’s difficult to say how long the process should take overall because it often depends on the time taken for the companies involved to get all the information they need. The Association of British Insurers state that pension money should be transferred from the original pension provider (once it has received all the necessary paperwork) to the new annuity provider within ten business days. Any longer than this is deemed an unnecessary delay.

Hold ups can sometimes be caused by the applicant themselves. Make sure you complete all the paperwork you receive as quickly, accurately and fully as you can. Send any documentation you’re asked for -- such as evidence of age -- quickly too. If you’re unsure what do to, ask.

And finally, feel free to chase up your old pension company and your new annuity company for progress regularly if you feel the process is taking too long. Make a nuisance of yourself if you have to! If you’re using an independent adviser they should be able to help you with this too.

Good luck!

*Source - Money Made Clear. Annuity income is based on a pension pot of £100,000 and provides a level pay out for a male aged 65. There are no spouse’s benefits included.  

This is a lovemoney.com classic article, originally published in September 2008 and updated