Boost your pension income by 20% a year

If you know this trick to squeezing the highest possible income from your pension, you're onto a winner!

Unfortunately, 2010 hasn’t been particularly kind to those of you who are getting ready to retire. Annuities continue to offer super low levels of income. And, despite holding steady at the beginning of the year, annuity rates have dropped off again this month.

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Why should you care?

Prevailing annuity rates when you come to retire are really important for one simple reason: an annuity converts your pension pot into a guaranteed income for life. So, the rates which apply at that time determine how high - or low - your income will be.

Unfortunately, rates are very low across the board at the moment, and I anticipate they will deteriorate for some time to come. The combined effect of rising life expectancy, expectations for long-term interest rates, and greater pressure on annuity providers to meet new solvency requirements (which are due to come into force in 2012) will most likely put more downward pressure on annuity rates.

How can you beat low annuity rates?

It’s true the prospects don’t look great, but there’s a relatively easy way you can stop poor rates from destroying your pension income.

The answer is to shop around.

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In pension terms it’s known as exercising the Open Market Option (OMO). In other words, when you draw close to retirement your pension company will make you an offer. This will tell you how much annuity income they’re prepared to pay you for the rest of your life based on the value of the pension pot you have built up with them.

The vast majority of retirees simply accept this initial offer without question. But that's potentially a huge mistake. In addition to the wider economic pressures on annuities, each annuity provider will individually price their rates. The difference between the best and worst can be astronomical. Pick a less-than-competitive provider and you can wave goodbye to a large portion of your income.

On the other hand, using the OMO to find the most competitive rate could boost your income by as much as 40%. To highlight what I mean, take a look at the tables below which compare the best annuity rates with the worst:

Today’s best rates - standard pension annuities

Source: Investment, Life & Pensions Moneyfacts. Annuities provide the same level of income for life based on a pension pot of £100,000.

And now for the worst:

Today’s worst rates - standard pension annuities

Source: Investment, Life & Pensions Moneyfacts. Annuities provide the same level of income for life based on a pension pot of £100,000.

For 65-year old men, the best annuity rate today would provide an annual income of £6,830. But the worst annuity provider would only pay out £5,710 for the same pension pot. Picking the worst provider - instead of the best - would mean you’ll lose out on almost 20% of your income. Or, putting it another way, you’ll miss out on £1,120, every single year, for the rest of your life.

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It’s exactly the same situation regardless of your gender or your age when you choose to retire. So it’s pretty clear it always pays to shop around, compare annuity rates, and choose the most generous one for you.   

Another way to boost your income

Using the OMO isn’t the only way you could get more income from your pension. The rates shown above relate to standard annuities only. But you could get even better value for money with an ‘enhanced’ annuity.

These specialist annuities are designed to provide a higher income if your life expectancy is considered to be below average. If you have a lower life expectancy - perhaps if you’re a smoker or you suffer from a medical condition - then you could enjoy a higher annuity rate simply because annuity providers expect to pay out an income to you for a shorter period.

You might be able to take advantage of an enhanced or smoker annuity if one or more of the following conditions applies:

• High cholesterol
• High blood pressure
• Overweight
• Diabetes (insulin dependent)
• Regular smoking
• A liver condition
• Emphysema
• Heart attack
• Parkinson’s disease
• Cancer

If you think you might qualify for an enhanced annuity, check out the difference it could make:

Today’s best rates – enhanced/smoker pension annuities

Source: Investment, Life & Pensions Moneyfacts. Annuities provide the same level of income for life based on a pension pot of £100,000.

Remember the highest standard annuity rate paid an income of £6,830 a year for a 65-year old man. But the same person could increase his income to £8,230 if he qualifies for the top enhanced annuity instead, just by shopping around. This is an uplift of more than 20% or an extra £1,400 in income every year.

Finally, those who suffer from a serious medical condition where their life expectancy is significantly below average, should choose what’s known as an impaired life annuity. This type of annuity will provide even higher rates based on the expectation of shorter total pay out period. Compared with a standard annuity, an impaired life annuity could boost pension income by as much as 40%.  

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