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Annuities

At the moment you don't have to buy an annuity with your pension fund.

I have had the feeling they are poor value for a long time but recently I worked out how I thought the fund would be diminished with age after you bought an annuity and the insurance company had to manage the fund to pay you an income.

So I looked up the life expectancy of a 65 year old male on the Government Actuarial Stastistical Table. It says that a 65 year old male could expect to live another 16 years.

Then I looked up some annuity rates and found that a 65 year old male could get an annuity rate of 7.2%.

Suppose you have a fund of £100,000. This buys you an annuity of £7,200 a year.

The insurance company now has your £100,000 and it can invest that money. It should be able to manage an income of 4.5% by investing in long term gilts.

So in the first year it should be able to earn £4,500 on your money and pay you £7,000. At the end of one year there is £97,300 left.

The question is, how much money is left after 16 years when, on average, all the males who bought a pension at age 65 are dead. OK some will live longer but some will die sooner. 16 years is the average.

The answer I get is nearly £39,000. That's nearly 40% of the original fund! So basically, on average, the insurance company gets to trouser 40% of the pension fund of a man who buys an annuity at age 65.

Well I'm stunned by that. So stunned I wonder if I've made a mistake. How can it be that so much of the fund remains for the insurance company. I know they have costs but it can't cost that much to maintain a pension fund. Once it's set up all they have to do is pay a monthly pension by standing order and bank the interest cheques they get. I bet that is paid electronically as well. The only other thing I can think of is to check up you are still alive so they know when they can trouser your money.

In brief...

Pensions

Pensions are just saving in a particular tax wrapper. There have been many changes in recent years and they are now worth considering as an alternative to dividends in order to avoid the dividend tax. Your money is locked up until you reach 55 though. In full... »

Pension Crisis

The government has recently picked up on what the rest of us have known for a while. People aren't saving enough for retirement. The thing is, it's true. But it's not the crisis we are led to believe it is. It isn't a matter of inadequate saving, it's more likely insufficient work. In full... »