Joint annuity: should you add a dependant to your pension?
Annuities have lost their appeal as rates have plummeted in recent years and the flexibility of drawdown has proved popular with those nearing retirement.
But the guaranteed income for life element of annuities is a major draw for retirees. A number of policies also allow you to add your husband, wife or civil partner (a dependant) to the scheme, ensuring they are provided for in the event of the policy holder’s (annuitant’s) death.
However, adding a spouse can be a major benefit or a disadvantage. Below we speak to Martin Tilley, director of technical services at Dentons Pension Management to find out more…
Why consider adding a spouse to your annuity?
Typically, on death of the annuitant, income payments stop and no money is returned.
An annuitant can choose anyone to become a ‘joint annuitant’ but for the purpose of this article, we’re referring to a husband, wife or civil partner – a spouse (if someone very young is selected for instance, this type of annuity is known as a ‘nominee annuity’).
This will provide reassurance to anyone who relies upon an annuitant’s income that they’ll continue to receive money after their husband, wife or civil partner (the policy holder) dies.
For example, you could build in a joint pension which continues on their death at 50% of their own annuity. So if a member annuity was £10,000, on their death, the dependant would receive £5,000 per year.
However, it’s not always 50%. The member can choose how much at the point of purchase, with common options being 25%, 33%, 50% and 66%.
Another important point to note is that any income from a pension annuity is taxed at the recipient’s marginal rate, so the annuitant until their death, and then the spouses marginal rate of tax thereafter.
Age, health and lifestyle are vital
The first thing to consider is could a surviving spouse get by without any continuing income from the annuity on the first death? If the answer is no, then some degree of dependant’s pension should be factored in.
But there are other consideration too. Is the dependant likely to outlive the annuitant? If the dependant dies first, the capital set aside from the annuity purchase price to pay for this benefit would be lost.
Simply put, if you think your spouse is likely to die before you as the annuity holder, it may not be in your best interests to add them.
However, it may still be worth getting a quote because this matter can be dealt with by using an impaired life or lifestyle annuity which requires the purchasers to complete a medical screening so the annuity provider can best assess the likely timescales of paying the annuity, and cost it accordingly.
Obviously, age will have an impact here as if the dependant is significantly younger than the annuitant it will cost more to buy a dependant’s benefit than had they been the same age as the dependant, as the likely pay period will be longer.
What are some of the drawbacks of adding a spouse to an annuity?
Aside from the dependant dying before the annuity holder, it’s important to note that when an annuity is bought, it is fixed and cannot be varied.
If a dependant’s annuity is built in, it’s costed at the date of purchase. If a dependant doesn’t need a continuing income, it’s probably not worth buying.
Another point is don’t just accept an annuity offer from your current provider – shop around and take advice to get the best annuity.
The costs involved
As with most things, this will vary depending on the type of annuity purchased and the age and health of both parties. But for a 60-year old buying a level pension with no guarantee period and no dependant’s benefits based on a £100,000 purchase price, they may get c.£4,773 per year.
If they build in a dependant’s pension which continues on their death of 50% of their own annuity, this drops to £4,490 – around a 6% reduction in annuitant income.
What about capital protected annuities?
Capital protection or sometimes ‘value protected annuities’ can pay a lump sum after an annuitant dies. For example, an annuitant has a purchase price of £100,000 and this buys an annuity of £6,500pa but the annuitant dies after eight years and eight payments.
The total payments made have been £52,000 so the difference between this and the purchase price can be paid (less tax). This would be payable to the annuitant’s estate.
You cannot combine capital protection with other death benefit options however.
Are there other ways to provide for a spouse?
Rather than go down the joint annuity route, you could consider flexi-access drawdown which gives holders the ability to draw an income without the finality of buying a guaranteed income for life.
This allows for any money left in the pension drawdown pot after death to be passed on to a surviving spouse either as a lump sum or as continuing income.
If the holder dies before the age of 75, then the money is paid out free of inheritance tax or income tax. After 75, payments will be taxed at the recipient’s marginal rate of tax.
Couples can also help each other in another way. As an example, a 60-year old husband has a private pension of £8,000 a year (at 65) and will be entitled to a state pension of £8,545 a year. This means his total income will be £16,545 a year, which is above the personal allowance which means he’ll fall into the 20% income tax bracket.
If the husband continues to work (self-employed), he can make payments of up to £3,600 into a pension designated for his wife. He’ll get tax relief on the contributions and will help provide a pension to his spouse who may not have any pension entitlement, other than the state pension.