Guest comment: Should you buy an annuity?

Tom McPhail (right), from adviser firm Hargreaves Lansdown, discusses whether retirees should still use their pension pot to buy a retirement income (called an annuity) following Government rule changes.

Pension investors have been granted greater freedom to decide how they draw their retirement cash from their pension fund. They are no longer forced to hand their money over to an insurance company in exchange for an income.

The question is now: how should you use this new freedom?

Until 6 April 2011, investors were forced to hand over their pot of money by their 75th birthday at the latest, in exchange for a guaranteed retirement income, called an annuity.

Once purchased, the availability of this income means you no longer have to worry about where your money is invested while in a pension pot or how long you will live for; instead, the insurance company keeps paying into your current account every month until you die.

The downside to this arrangement is you lose control of your original lump sum. And when you die, the money is lost.

Greater control

Because of this, many people don't like annuities. The government rule changes allow investors to keep control of their fund, up to the day they die and to then pass at least some of it on to the next generation.

This is achieved by using what is called drawdown, where you can withdraw money directly from your fund.

The problem is many people tend to underestimate how long they will live; for someone in their mid 60s that is likely to be 20 years or more, meaning they could run out of cash eventually.

They are also unlikely to be in a position to tolerate significant investment losses given the value of their pot could rise or fall in line stock market performance.

In spite of their unpopularity, annuities are good value for money, delivering strong guarantees and an income for life, however long you live.

The important caveat with annuities is that it is vital that you shop around among annuity providers because if you don't, and simply take what your pension provider offers, the chances are that you won't get the best deal.

Annuities usually still best

For most people, the best way to take their income in retirement will still be by buying an annuity, what around 90% of retiring private pension investors do today.

More and more people will choose to do this later in life, though; preferring to use a drawdown when they first retire, before switching to an annuity in their 70s or 80s.

The advantage of this is that they will be more likely to qualify for more cash if their health deteriorates.

They will also be in a better position to make an informed decision about any additional annuity options such as a continued income for their spouse after their death, and inflation-proofing.

I can't emphasise enough that while the new freedom and choice which the Government has granted to pension investors is good news, it only works if you actually make a choice.

Everyone should take the trouble to shop around at retirement and not simply take the first deal that is put in front of them.