Can I buy an annuity with cash from savings or an ISA? I’ve heard the funds must come from a pension fund – is this true?

Martin

Tom Selby, AJ Bell Head of Retirement Policy, says:

An annuity is a guaranteed retirement income for life paid to you by an insurance company, usually in return for your pension pot. However, you don’t have to have a pension fund to buy an annuity. You can use any pot of money to buy a ‘purchased life annuity’.

Part of each income payment from a purchased life annuity is treated as a return of the original lump sum paid – this is classed as the ‘capital’ element, which means you won’t be taxed on this original payment. However, the difference between the gross income payment and the capital element is taxable as savings income.

If you have a defined contribution pension, you can use it to buy a ‘lifetime annuity’. Your annuity income is subject to income tax.

Annuities provide certainty in retirement as you will know exactly how much income you’ll receive. But if your circumstances change, you won’t be able to flex your income to meet your needs.

Once you buy an annuity, there is no going back. You need to be sure it is the right route for you and shop around the market for the most appropriate product and the best rate.

There are different flavours of annuity to suit different needs and preferences. For example, you can choose to opt for a ‘level’ annuity or an ‘escalating’ annuity. The former will give you a higher starting income, but your spending power will be steadily eroded over time by inflation. The latter will give you some protection against rising prices, but you’ll be offered a lower starting rate.

When buying an annuity, tell your insurer of any medical or lifestyle factors that may limit your life expectancy, as disclosing these could mean you get a better deal.

If you are comfortable taking some investment risk and prefer more freedom, you might want to consider drawdown – although you will need to have a defined contribution pension. In drawdown, your fund will remain invested, with the potential to grow over the long-term, and you’ll have total flexibility over how and when you access your money.

This flexibility comes with responsibility – namely ensuring your fund lasts throughout your retirement by managing withdrawals sensibly. You also need to be comfortable with the risk your investments might fall as well as rise.

Another option is to take ad-hoc lump sums from your pension, with a quarter of each lump sum tax-free and the rest taxed in the same way as income.

It is possible to combine annuity and drawdown to get a balance of security and flexibility.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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