Updated 16 May 2022
Do you have a GAR? Have you checked, just in case? Do you know what a GAR is? Well, what it could be is a way to double or even triple your retirement income – so if you have one, you need to hang on to it with both hands. Article by Nick Green.
We know a lucky chap. Plenty of people have lost out (and some never even knew it) but this man called up his financial adviser. He wanted to transfer his pension pot to a different scheme, as he didn’t think it was performing very well. The adviser looked into it and very quickly called her client back, telling him: whatever you do, don’t move that pension. Leave it where it is.
Why the fuss? Because the adviser had spotted something that her client hadn’t realised. The pension scheme included a guaranteed annuity rate (GAR), and this rate was 12 per cent. Being pretty clued-up financially, he immediately knew what this meant, and realised what he’d been on the verge of throwing away.
You may still be wondering, what does a GAR do, and is 12 per cent good? The answers, respectively, are ‘A lot’, and ‘Oh, yes.’
First, let's explain what an annuity rate is. As you may already know, an annuity is a regular income paid to you for life. The amount is always predictable, and the money can never run out. This element of certainty is what has made the annuity the most popular retirement option for years (at least until pension freedom happened).
The problem with annuities is that the rates have fallen pretty low lately. The annuity rate is the factor that determines how much annual income you receive. This depends on a range of factors including your age, state of health and even where you live, but most of all on the market itself.
Let’s suppose you had a pension pot of £133,333 (a convenient figure for doing the maths) and take your 25 per cent tax free lump sum. This leaves you with £100,000 with which to buy an annuity. Assuming that you retire at 65 in good health and want a no-frills annuity, you can currently get one that pays around £5,000 a year. In other words, about 5 per cent of that £100,000. If you want additional features, such as a joint life annuity (to cover your spouse too) or one that rises with inflation, the rate would be lower – you might be looking at closer to four or even three per cent.
Today, annuity rates are low. But back in the 1980s they were much, much higher… which is what makes those old guaranteed annuity rates so exciting.
A GAR is a feature of some pension schemes, guaranteeing that you can buy an annuity at a particular percentage rate. Common rates offered are around 9 per cent to 11 per cent (occasionally higher), so are roughly double the best rate most people can achieve on the open market. In the above example, a GAR of 11 per cent would give you £11,000 a year instead of £5,600 a year – a difference of £108,000 over a 20 year retirement (i.e. better by more than the original value of the pension pot itself).
The kinds of pension that most often include a GAR are with-profits pensions taken out before 1988 – they are sometimes known as retirement annuity contracts or Section 226 policies.
It's not always easy to find out if you have a guaranteed annuity rate. You need to go through your policy paperwork carefully, or better still ask a financial adviser to do it for you. Often the term ‘guaranteed annuity rates’ won’t be used at all, so look for language like ‘benefits’, ‘preferential’ or ‘guarantee’. It’s also a good idea to ask the provider straight out.
Sadly, some providers won’t fall over themselves to remind you about your GAR – for the simple reason that it will cost them a lot. They may even send you letters encouraging you to move to their newer, superficially more attractive but non-GAR pension scheme. A healthy scepticism here may serve you well.
Even if you do have a GAR on your pension scheme, there may be restrictions on when you can exercise it. For instance, some schemes make it a condition that you must buy the annuity on your 60th birthday – no other day will do. Others might have a more generous window of several months, or just a minimum age – but whatever the restriction, make sure you know about it beforehand.
In most cases, a GAR will beat current annuity rates hands-down. However, if you are in poor health that could reduce your life expectancy, you may qualify for an enhanced annuity, in which case you may achieve a better rate.
Pension freedom has made it possible to cash in your pension pot or reinvest it instead of buying an annuity. Before you make any decisions in this area, check and double check to see if your pension comes with a GAR. If it does, you could lose a life-changing amount of money by cashing it in rather than taking the guaranteed annuity. This is yet another reason to seek independent financial advice when approaching retirement.