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Financial Products Series: Annuities



The Financial Products series, to briefly explain and evaluate a wide variety of financial products/ This series should be useful to anyone who wants to gain a brief knowledge of different financial products.

This article is the sixth in a series of 12 that outlines in simple terms different financial products, how they work, advantages and disadvantages, and how I would rate them. The Products that this series will cover are:
  1. Shares
  2. Structured Products
  3. Cash
  4. Current Accounts
  5. Savings Accounts
  6. Annuities
  7. Certificate of deposit
  8. Options
  9. Treasury Bills
  10. Bonds
  11. Tracker funds
  12. Credit
If any of you can think of any other financial products that you feel deserves a place on this list please get in touch and let me know, or else comment below.

Annuities

What is an Annuity?

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An Annuity is a financial product that is bought  once a person retires. The Annuity then pays out a monthly (usually) income for the rest of that person's life.

Annuities are purchased with money saved up in a pension but can also be purchased with other types of savings.

The amount of income that a person will earn will depend on several bits of key information. Are they a smoker? Are they in good health? How likely are they to develop certain illnesses?

Annuity and Taxes

The income generated by an annuity is not tax free. Typically it is subject to the base rate of tax unless the person was a higher rate tax payer when they were in employment.

Pension holders have the option of taking out 25% of their annuity in tax-free cash but clearly this will mean that their future income from their annuity will be lower.

What are the different types of Annuities?

Conventional Annuities: Like all annuities this provides a regular income along with options to provide a loved one with an income for when you die and also could include clauses for dealing with inflation. The downside is that once this is taken out, there's no going back on your decision. It is for life.

Enhanced Annuities: This type of annuity has all the pros and cons of a conventional annuity. However, if you qualify, healthwise, you may be entitled to up to 40% more income from your annuity with an enhance annuity.

Investment Linked Annuities: This annuity means that your future level of income is linked to a particular fund. Clearly if the fund does well you will receive a higher income and if it does badly you will receive a lower income. These types of annuities are also subject to administration charges.

Purchased Life Annuities: These annuities are extremely similar to conventional annuities. They can be purchased so that the annuity provides you with an income for a certain period of time or for life. These annuities can be purchased with savings or with the tax-free cash taken out of a pension.

Drawdown Pensions: This financial product allows you to draw a pension without buying an annuity. The rest of the money remains invested in the pension fund. There are quite a few things to watch out for when drawing on a pension in this way. This sort of pension has administration fees. It is also suggested that you should have at least £100,000 in your pension to cope with falls in investment performance. However, this type of pension gives you flexibility in the amount you may wish to withdraw. Also if you die the remaining amount can be given to loved ones, subject to a 55% tax or used to buy an annuity. Alternatively you can bequeath the remaining amount to charity tax free.

Third Way Annuities: These sorts of annuities have in built minimum income guarantees if the fund falls below a certain level. They also allow for a rise in investments providing holders with an increased income. There are many different types of these annuities and you would need to speak to a financial adviser or search around to understand them all.

Overall conclusion

Everyone will need a pension at some point (the earlier the better) and hence an annuity is a good way to receive a regular income, after administration charges, movements in the underlying fund and taxes.

Score: 7

Advice: Speak to a financial adviser to see what sort of pension and annuity suits you. Furthermore, check if your employer has any sort of pension scheme and try to maximize it each month, especially if the company matches your contributions.

Readers, what are your opinions on annuities? Let me know what your plans are for when you retire.



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1 comment

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