About open market option
people retiring in the UK over the next few months
will have received information about their pension
fund from the provider, including details for buying
annuities. The provider's annuity offered, however, may not
be competitive and an open market option could add
up to 30% more pension income each year for the
rest of the annuitant's life.
An open market option means an annuitant
is free to buy a compulsory purchase annuity (or
pension annuities) from any provider in the market,
and this applies to a with profits annuity as well as a standard annuity.
Although every one of the approximate 350,000 people retiring
in the UK in 2011 could consider an open market
option, but over 2/3rds still did not shop around
to find the best annuities. Many could receive extra
income by up to 30%, worth thousands of pounds
every year for the rest of their lives.
Buying the right pension income is very important
as once bought, annuities cannot be switched to
another annuity provider, cannot be changed to
a different type of annuity and cannot be altered
in any way for the rest of the annuitant's life.
Once the capital from the pension
fund has been spent on an annuity, there is
no opportunity for any of this capital to go to
a beneficiary on the death of the annuitant.
There are many aspects to the retirement options.
These could be the features that can be added
to annuities, whether an individual suffering
from ill health, is a smoker or is overweight
could benefit from an enhanced
life annuity, whether other options are more
appropriate such as phased retirement of pension
drawdown and how to select the best annuity rates offered by providers which can change from one
week to the next depending on their cashflow requirements.
It is important that if an individual is in any
doubt when taking the open market option route,
they must seek an annuity and pension bureau offering specialist
advice from an independent financial adviser
(IFA). The advice given is paid for by the annuity provider
as part of their distribution costs, even if an
individual goes direct. Advice has the added security
that if the annuity is inappropriate to your needs,
there is a route for complaint and compensation.
At retirement the individual can use a money purchase fund, personal or company, to buy an annuity using an open market option to search for the highest pension annuity. Once you have purchased an annuity it cannot be changed, so learn more about annuities, compare annuity rates and before making a decision at retirement, secure a personalised annuity quote offering guaranteed rates.
Cost of delay
Currently many people believe that standard annuities
from their existing provider offer "poor value for money".
Given that many of them already receive incomes from a final
salary or public service schemes, they may not need the income
from other pension arrangements they have accumulated such
AVC, FSAVC, retirement annuity or personal pensions and therefore
decide to delay purchasing pension annuities.
At an individuals retirement date, by delaying the purchase
of a standard annuity by a year, the annuitant will have lost
one years income and this cost of delay is far greater than
any possible increase in rates in a years time. The annuitant
must also consider the benefit of enjoying the income now
and for longer when they are healthy, as there is a greater
likelihood of ill health the older the annuitant becomes.
For example, take a male or female with £100,000 in
a pension choosing an open market option level annuity, no guarantee paid monthly
in advance, assuming that the existing fund continues to grow
at 5.0% per annum (after charges) and retiring at ages 55,
60 and 65. By delaying either 1, 3 or 5 years it will take
a number of years before a deferred higher annuity income
will 'catch-up' with the income already paid, or number of
years to break even. This time could be longer than the individuals
life expectancy (years to live), or mortality as follows:
|MALE - years to breakeven
|Time Period of Delay
|FEMALE - years to breakeven
|Time Period of Delay
|Example - For a male aged 60 that
defers buying an annuity for 1 year, it will then
take him 12 years to recover the lost income due
to the cost of delay, or half of the annuitant's
life that remains free
The above tables assume the fund is based on equities, it
grows at 5.0% per annum (after charges) and that there is
no improvement in the annuity rates in the future. If the
fund does not increase during the delayed period, all of the
above examples will not break even during the annuitants lifetime.
The tables clearly show the effect of mortality
drag by the annuitant not participating in the benefit
of annuities. If the annuitant is not dependant on the income
from their other pension arrangements and willing to accept
a slightly higher risk, a with profits annuity would allow them to receive an income
now and therefore avoid the cost of delay.
Single or joint annuity
For a compulsory purchase annuity acquired from a pension
fund using an open market option, it must be taken between the ages of 50 to 75 years whereas a purchased
life annuity can be bought at any time. Both annuity types
can be purchased as single life annuities where the annuitant
does not have a partner and this feature can also apply to
a with profits annuity.
This means that the pension income from a single life annuity
will be greater than a joint life annuity because due to mortality,
it is going to be paid out for a shorter period of time. The
annuity is paid for the life of the annuitant and ceases on
If the annuitant is married or has a partner that does not
have a source of independent income, then the annuitant may
want to share their pension income or the income from a lump
sum by using a joint life annuity, providing security on the
death of the annuitant by paying a survivors pension.
For a joint life annuity the partner will receive a survivors
pension on the death of the annuitant and this feature can
also be added to with profits annuities. The amount of the income is selected
at the outset by the annuitant and payable for the whole of
the survivors life, cease on their death. A dependent could
also receive an income, such as children but this would normally
be paid until age 18 years or the end of further education.
Using an open market option the annuitant can select the percentage of their annuity income
to be paid to their partner in the event of death. An equal
amount is known as a 100% survivors pension and other typical
percentages would be half or 50% survivors pension, two thirds
or 66.67% survivors pension, although any percentage can be
selected. The higher the spouse's pension selected the lower
will be the pension
income paid to the annuitant.
The expected ages at death are reflected in the price paid
for pension annuities. Some annuitants live beyond these life expectancies
and as a result, receive more money from the annuity income
than the original pension
fund plus interest. In the UK the average life expectancy
for a person depends on their current age as the following
Other annuitants die early and receive only a fraction back
from their original pension fund capital and creating a mortality
profit for the insurance company. Part of this money is
returned to the other annuitants in the form of more income.
This means that for an individual who invests through pension
fund withdrawal, to match the return in an annuity an extra
return is required. This has the effect of creating a mortality
drag on the pension.
This means that an individual with poor health and lower life
expectancy will find annuities unattractive. As a result,
life companies offer enhanced or impaired
life annuity for people with shorter life expectancies
such as smokers, people that are overweight, of a certain
occupation or even living in a particular location in the
UK. Such open market option annuities can add as much as 30% to the standard annuity rates,
or even more for an impaired life or enhanced
Shop Around for a Pension Annuity and Save
On retirement most people use their accumulated pension fund to purchase a pension annuity. This pension annuity should provide an adequate annual income for a comfortable life in retirement, and the best way to find the best annuity available is to shop around on the open market.
By using your open market option you have a much greater choice of annuities and annuity rates, which can differ significantly depending on provider and other factors such as your lifestyle and your health. Here at Sharing Pensions our aim is to help you find the best possible pension annuity by comparing annuities on the open market.
The benefits of doing so can be great and you could even increase the income from your pension annuity by up to 25%. That can equate to a serious amount of money and it could make all the difference to your quality of life once you have retired.
So, if you are planning to buy a pension annuity, use Sharing Pensions to browse the market and find one that suits your needs and provides you with the most income.
By purchasing a level annuity income, an annuitant will receive
a greater income initially than if they purchase an open market option annuities with RPI escalation or fixed rate escalation. If inflation
remains low, it could take more than 20 years for a pension annuity
with escalation matches the return from a level annuity. One
way of having a higher income is to initially select a with profits annuity. This can pay an income in retirement
that is higher than the level annuity.
Therefore, if the annuitant is aged 65 and dies at the age
of 85, there would be no difference between a level and escalating
annuity. However, if inflation rises during this time then this could significantly reduce
the buying power of a level annuity income and hence reduce
the annuitant's standard of living.
The timing of an annuity purchase can also make a significant
difference to the income over the life of the annuitant as
the following table shows. This assumes a £100,000 pension
annuity purchase for a level annuity paid in arrears with
no guarantee period.
|Timing of an annuity purchase
|Annuity table - the annuity rate
shown above is based on a pension annuity of £100,000
and should be used as a guide only. For an annuity
rate specific to your circumstances you should complete
For example, an annuitant with a £100,000 pension fund
after taking the tax free lump sum could, with a level annuity
purchase an income for a male aged 65 of £5,962 pa year in June 2012.
This is compared to an annuity with 3% escalation that would
provide a pension income of £4,193 a year.
Although annuity rates have been at their lowest point for
the past 40 years, so long term inflation is under control within a
range of 1.5% to 3.0%. This means the guaranteed income from
a pension annuity whether level of escalating can offer an adequate
return for the purchase price, especially when other investment
options such as equities are falling or volatile.
RPI and LPI escalation
For a pension income to maintain its value in the future,
it needs to rise with inflation. This means that the annuity
must be indexed-linked to the Retail
Price Index (RPI). Alternatively, the pension annuity
could also be escalated by limited
price indexation (LPI) which is inflation rises limited
to a maximum of 5% growth. This basis is used for any portion
of the pension fund containing protected
In order for the insurance company to be in a position to
pay the annuitant, it must purchase index-linked gilts that
provide an index-linked income and redemption values in the
future. The cost of RPI escalation depends on inflation and
therefore could be cheaper or more expensive than a fixed
rate annuity, but certainly more expensive than a level annuity.
For example, a £100,000 pension fund after taking the
tax free lump sum could, with RPI escalation, use an open market option to purchase a single
life annuity for a male aged 60 of £3,366 income a year in 2011.
This is compared to a level annuity that would provide a pension
income of £5,944 a year in 2011. One way of having a higher
income is to initially select a with profits annuity. This can pay an income that is much higher
than the RPI escalating income at the start but also has the
possibility of rising in the future.
Fixed rate escalation
A pension annuity is usually paid on a fixed rate basis over
the life of the annuitant, either as a level annuity or escalating
at a fixed percentage. Although any percentage can be selected for an open market option,
the usual rates are 3% or 5% per year.
In order for the insurance company to be in a position to
pay the the annuitant, it must purchase Sterling fixed interest
securities such as UK Government securities or gilts. The
amount of income that can be purchased with a pension fund
depends on the yields for long-term gilts and in particular
gilts with a redemption periods of 15 years or more.
Therefore as interest rates have fallen, so the yields on
annuities have fallen and this affects the income that can
be paid to an annuitant. Nevertheless, if inflation remains
under control in the future at between 1.5% to 3.0%, the income
from a 5% escalating annuity will slowly increase the standard
of living of the annuitant over time.
For example, a £100,000 pension fund after taking the
tax free lump sum could, with a fixed rate of 5% escalation,
purchase a single life annuity for a male aged 60 of £3,079
income a year in 2011. This can be compared to pension annuities with
RPI escalation that would provide an income of £3,366
a year. One way of having a higher income is to initially
select a with profits annuity. This can pay an income that is much higher
than the fixed rate escalating income at the start but also
has the possibility of rising in the future.
The annuitant can decide that the annuity income using an open market option is to be
paid for a guaranteed period of time from the start, typically
for 5 or 10 years and this feature can also be added to a with profits annuity. This means that if the annuitant dies
shortly after taking the pension annuity, the income must continue
be paid for the time of the guaranteed period remaining.
The annuity can be paid as an income, usually to the estate,
or the insurance company may be willing to capitalise the
amount of the annuity remaining and pay this as a lump sum.
This lump sum is typically less than the value that would
have been paid as an income to reflect the investment loss
to the insurance company of paying the money sooner.
The cost of a 5 year guaranteed period is approximately 1.7%
of the annuity purchase price. For example, for every £1,000
per year income the annuitant will pay £17 per year
for this guarantee, leaving a gross income of £983 per
year. However, from year 6 onwards the guarantee no longer
applies and if the annuitant is still alive, he or she continues
to receive only £983 per year and this is not such an
Depending on the individual's requirements, using an open market option the pension annuity can
be paid on a monthly, quarterly, half yearly or annually and
this feature can also be added to a with profits annuity. The more frequently the income is paid,
the more expensive the option and the lower the annuity income.
For example, if a male aged 65 decides to take his annuity
annually rather than monthly, this adds 4.2% to the annuity rate
paying a higher income for the rest of the his life. For a female aged 65 this adds
3.8% to the income for the rest of her life.
Advance or arrears
For all of the premium frequency options, the annuitant can
decide to take the payments from his open market option in advance or arrears. This
feature can also be added to a with profits annuity. For example, if the annuitant takes a
quarterly income this can be paid at the beginning of the
period, in advanced, or at the end of the period, in arrears.
For example, if a male aged 65 decides to take his monthly
annuity in advance, this reduces the annuity rate by 0.6% paying a lower income for the
rest of the his life. For a female aged 65 this reduces the
income by 0.8% for the rest of her life.
Where the annuitant takes the income in arrears, for an open market option this can
be with or without proportion. In the event of the annuitant's
death during the period he or she was waiting for the next
pension annuity payment in arrears, annuities with proportion will
pay to the estate a proportion of the payment due.
For example, it the death occurred halfway through the month
for an annuity paid monthly, then half of the annuity would
be paid to the estate. The cost of proportion is low and for
a male or female aged 65 with proportion reduces the income
by approximately 0.2% for the rest of his or her life.
For pension annuities on a joint life
annuity where using an open market option the annuitants have selected both a guaranteed
period and a survivors pension, on the early death of the
annuitant only the income during the guaranteed period would
At the end of the guaranteed period the survivors pension
selected would then become payable. However, if the annuity
selected is with overlap, then the survivors pension is paid
immediately in addition to annuitants pension until the end
of the guaranteed period.
For example, a pension annuity of £10,000 has a guaranteed
period of 5 years and a survivors pension of 50% with overlap.
If the annuitant dies 2 years later, the £10,000 will
be paid for a further 3 years and a survivors pension of £5,000
is paid immediately. The spouse receives £15,000 for
3 years and when the guaranteed period ends, only the £5,000
from the survivors pension is paid until the end of the spouses
Retirement age limits
As a result of
Pensions Simplification, the minimum age of retirement when an individual can take their benefits has changed from 50 to age 55. This applies to taking the tax
free lump sum, purchasing open market option pension annuities and income drawdown.
From 6 April 2010 it has not been possible for individuals
under the age of 55 to take pension benefits. The only exceptions
are the following:
||People who retire due to ill health;
||Members of occupational pension schemes
that already have contractual rights to retire early;
||People with special occupations with
lower retirement ages such as sports people.
Prior to A-Day the Inland Revenue
did not allow an annuitant to delay the purchase of a pension annuity
beyond the age of 75.
Simplification, from 6 April 2006 both money purchase
occupational pension schemes and private pensions, such as
personal or stakeholder pensions, are standardised under the
rules. This allows an individual to purchase an annuity or
continue in drawdown after the age of 75 and is known as alternatively
secured income (ASI).
ASI has been introduced in particular to assist those individuals
with religious beliefs that prevent them from purchasing an
annuity on ethical grounds. The
minimum ASI can be £0 per annum and the maximum
is 70% of the Government Actuaries Department (GAD) annuity
tables for an annuitant aged 75, and reviewed annually.
This low limit to continue in drawing an income has been
set to discourage people that have no religious reasons
for not purchasing annuities.