Understanding annuities

As already explained, money purchase, personal and stakeholder pension funds must eventually be used to buy an annuity. This is called a compulsory purchase annuity (CPA) and all the receipts are taxable.

Voluntary purchase of an annuity - such as with the tax-free lump sum - is called a purchased life annuity (PLA) and only the interest element of the receipts are taxable (the capital refund element is about half the receipts).

There is a wide choice of type of annuity, such as single life, joint life, impaired life (where you have a potentially terminal health problem, leading to higher rates) and they can be flat-rate or indexed. It is also possible to have an annuity based on the stock market, with variable returns.

There is also a wide variety of rates for each type, so make sure your pension provider gives you all the alternatives and makes it clear whether there is any penalty for shopping around. Because women on average live longer :han men, their rates are lower.

Planning for your retirement

Get a forecast of your state pension entitlement about five years before you intend to retire, to see if you can get more by making additional contributions - ask your local DSS office for an application form.

Shortly before retirement occupational schemes normally provide a quote showing your pension and that is when you decide about taking a cash lump sum.

With a personal pension the provider will tell you the lump sum available and give an indication of annuity rates. This is when you decide whether to defer taking the pension.

Prepare a new income and expenditure budget for after retirement. Consider whether to use your lump sum to reduce your mortgage.

A year or two before retirement, review your investments to see if you should start switching from growth to income investments.

Summary points

• Do you know your state pension position, especially if you are nearing retirement?
• Have you considered making AVCs to supplement your company pension?
• Consider switching your personal pension if the charges are high.
• Can you take advantage of the new stakeholder pension?
• If you have to buy an annuity with your pension money, give careful consideration as to which type of annuity is best for you.
• *If nearing retirement, have you prepared a post-retirement income and expenditure budget, to see where you stand.