What is an annuity?
An annuity is a financial product sold by insurers that pays out an income to an individual for the rest of their lives. An annuity is the only product that ensures a secured income for life. For this reason, annuities will especially appeal to individuals who want an investment that provides a known income in retirement.
An annuity can be purchased from the proceeds of:
- A company pension plan
- A personal pension plan
- Additional Voluntary Contributions (AVCs)
- Death benefits from an occupational pension scheme (where the annuity is paid to a beneficiary)
- An Approved Retirement Fund (ARF)
- Personal Retirement Savings Account (PRSA)
People generally invest in annuities at retirement. Most retirement plans operate by accumulating a fund of money on behalf of an individual over the period of their working life. By the time the person reaches retirement the pension fund will have achieved a certain value. This value (also, referred to as the capital sum) depends very much on the level of contributions that have been paid into the retirement plan over the individual’s years of service. The higher the level of contribution, the larger the fund, although other factors like investment returns will also have a bearing on values.
Why are annuities so dependable?
Unlike some investment products, annuities are not invested in stocks and shares and therefore, not subject to the same type of volatile market fluctuations that these assets are exposed to. The attraction of annuities is that they offer consistency of income over the lifetime of the person. Market volatility may come and go but an income from an annuity is paid by Irish Life regardless of investment conditions.
How do annuities work?
When you reach retirement you will have accumulated a fund of money. Let’s suppose that fund of money equals €100,000 and let’s also suppose that out of that amount you take a cash free lump sum of €25,000*. Then you use the balance to purchase an annuity. The insurance company accepts the money, agrees the price based on prevailing annuity rates, and will provide an income for life to you (the ‘annuitant’) for as long as you live.
*The amount of available tax free lump sum will vary from person to person depending on scheme service and type of pension plan. The calculation of your lump sum depends on the rules of your product or pension arrangement and you should check this with your Financial Advisor (assumed 25% of the accumulated fund). The overall tax free cash from all pension arrangements cannot exceed €200,000. Tax free lump sums taken on or after 7 December 2005 will count towards using up the tax free amount. So if you have already taken tax free cash totalling €200,000 or more since December 2005, any further retirement lump sums paid to you will be taxable.
| Accumulated fund at retirement | €100,000 |
| Less cash free lump sum | €25,000 |
| Balance available for annuity | €75,000 (the ‘purchase price’) |
| Income from the annuity | €3,900 per annum payable for life** |
**Based on a sample annuity rate of 5.3% for a 65 year old and excluding any ‘additional features’ as outlined below. Used for Illustration purposes only. The actual rate will depend on the date the annuity is purchased.
Warning: These figures are estimates only. They are not a reliable guide to the future performance of the investment.
Are annuities flexible?
Yes, annuities are flexible and there are a number of additional features you can select when purchasing an annuity:
- Single Life/Joint Life. An annuity can be purchased on a single life basis i.e. ceasing on the death of the individual, or on a joint life basis where some or all of the annuity can continue on to a second life (usually the spouse/civil partner), assuming they live longer than the main annuitant. The percentage of annuity transferring over to the second life is typically between 50% and 66% (the ‘reversion rate’).
- Minimum payment period. Although not essential, most annuities come with a minimum payment period of 5 or 10 years. Even if the annuitant dies, after say only 3 years (in a Single Life Annuity), payments will continue to be paid into the estate of the deceased for a further 2 or 7 years respectively. In the case of annuities with a minimum payment period of less than 5 years a lump-sum may be paid by the insurance company in final-settlement**. The lump-sum will reflect the balance of payments due under the minimum payment period. If an annuity has no minimum payment period, the annuity ceases immediately upon death.
**Revenue do not allow this (lump-sum payment) feature on annuities offering a minimum payment period of more than 5 years.
- Overlap. Overlap is relevant to Joint Life Annuities that feature a minimum payment period. Upon the death of the main annuitant, an annuity ‘with overlap’ will immediately commence paying the second annuity to the surviving life and in addition, will continue to pay the main annuity to the second life up to the expiry of the minimum payment period.
- Escalation. Annuities can pay a flat level of income each month or they can pay an income that escalates in the course of payment by a fixed pre-selected percentage or by a percentage that’s linked to the Consumer Price Index (CPI).
Will choosing these additional features affect the rate?
Yes, choosing any of the above options will impact on the amount of income payable from an annuity and this will depend on which and how many options are selected. In Example 1 above we showed a standard annuity, which was returning a notional rate of 5.3% per annum. You can expect this rate to decrease when you choose additional features.
In the first example, the male aged 65 is buying an annuity with a purchase price of €75,000 (after taking the tax free lump sum). By choosing some of the options mentioned earlier, the typical effect on the annuity rate would be as follows:
| Type of Annuity | Sample Annuity Rate | Gross Income**** |
|---|---|---|
| Single Life annuity | 5.3% | provides an income of €3,900 per annum |
| Joint Life (50% payable to spouse) | 4.8% | provides an income of €3,550 per annum |
| Joint Life (50% plus 3% escalation) | 3.2% | provides an income of €2,350 per annum |
Some features affect rates more than others. You can see from the above example that choosing escalation has quite a significant bearing on rates. Please note that it is not possible to add additional funds to the Capital Sum on retirement in order to cover the cost of these additional options. An annuity can only be purchased using funds from an exempt revenue approved arrangement..
****Figures are shown gross before any deductions for tax. For more details on taxation, please see below.
Warning: These figures are estimates only. They are not a reliable guide to the future performance of the investment.
What happens if I die?
What happens in the event of death depends on the type of annuity selected.
| Type of Annuity | Upon death |
|---|---|
| Single life no minimum payment period | The annuity ceases. |
| Single life with minimum payment period | The annuity is payable for at least the duration of the minimum payment period and thereafter ceases upon death. |
| Joint life/no minimum payment period/50% reversion/no overlap***** | 50% of the annuity continues to the second life for their lifetime and ceases on the death of the second life. |
| Joint life/with minimum payment period/50% reversion/with overlap***** | The main annuity is payable for at least the duration of the minimum payment period. 50% of the annuity is payable to the second life from the date of death of the main annuitant even if this occurs within the minimum payment period. The second annuity ceases on the second death. |
| Joint life/with minimum payment period/50% reversion/no overlap* | The main annuity is payable for at least the duration of the minimum payment period. 50% of the annuity is payable to the second life upon the death of the main annuitant but will only commence at the end of the minimum payment period. The second annuity ceases on the second death. |
*****Note: These examples assume that the second life does not pre-decease the main annuitant. In such an event the annuity ceases on the death of the main annuitant, except if there is any time remaining on the minimum payment period.
Can I cash in or amend the terms of my annuity?
No. Under current Revenue rules it is not possible to cease an annuity and trade in any balance for cash. Neither is it possible to alter any of the features of the annuity (e.g. the rate of escalation or switch from single life to joint life) once the annuity has been purchased. Annuities are designed to provide security and consistency of income during retirement. Once the initial set of options are chosen they cannot be changed or amended later. For this reason you are strongly advised to seek professional advice before purchasing an annuity.
What about tax/Universal Social Charge (USC)?
Income from an annuity is taxed in the same way as any other income so the rate of tax and USC will depend on your individual circumstances.
All death benefits paid under an annuity may be subject to income tax and/or inheritance tax.
In all cases it is the responsibility of the annuitant to contact their local Revenue Office to ensure their annuity is taxed correctly before payments commence. The Revenue Commissioners can tell you the correct rate of income tax that you should pay on your annuity.
Any tax credits should be assigned to Irish Life (Pension Payments) under tax reference 0087900D. Until we receive a Tax Credit Certificate from the Revenue Commissioners telling us what rate of tax to apply, Irish Life is obliged to deduct Income Tax from your retirement income at the emergency tax rate.
Can my income increase while in payment?
Irish Life offers several different option around how your income can vary while in payment. The preferred option must be chosen at the outset.
Fixed Increases
Under this option the regular income for life is fixed from the outset (either flat or fixed increases apply e.g. 3%p.a.).
- Advantage: You know exactly the amount of income you are going to receive for the rest of your life.
- Disadvantage: It isn’t inflation-proof and offers no protection against the effects of higher than expected inflation. As time goes by, its purchasing power may diminish, if inflation exceeds any increase.
Inflation Linked Increases
The income from this type of annuity escalates in the course of payment as Consumer Price Index (CPI) varies. The rate of escalation is usually capped at a maximum rate e.g. CPI max 5% p.a.
- Advantage: The purchasing power of your income is somewhat protected against the effects of inflation.
- Disadvantage: Choosing escalation on you income will impact on the initial amount of pension you can expect from your fund. The amount would be less than if you choose a pension with no escalation.
Additional Options
The following options can be added to any of the above mentioned annuities, at an extra cost:
Dependants' Pension
You can choose for an income amount to continue to be paid to your spouse/civil partner or other financial dependants following your death.
Minimum Payment Period
You can choose to have your annuity paid for a minimum period, for example, five or ten years. If you should die during this period your annuity will continue to be paid to your dependants until the minimum period has expired. The annuity purchased will be lower than an annuity with no minimum payment period.
Additional Options
Irish Life annuity products also offer the features mentioned earlier, for e.g. providing for a Dependant’s Annuity, incorporating a minimum payment period into the contract.
How do I get a quote?
Your financial Adviser can arrange to do a quotation on your behalf. You should note that quotations are usually only valid for 14 days. After that time you may need to get an updated quotation. Alternatively you can check our website www.pensionchoice.ie
What information do I need to provide if I decide to purchase an annuity?
If you decide to purchase an annuity, you should complete an annuity proposal form, provide your PPS number (this is required for administrative and taxation purposes), evidence of age and evidence of marriage or civil partnership (if a contingent spouses/civil partner pension is being purchased).
You should then arrange for payment of the purchase price of the pension (if it’s not coming from an Irish Life scheme).
