Annuity Rates - Options for calculating future annuity payments

Q - We are scheduling a future annuity and expect payments to be calculated based on 4.5% of the amount annutised. The resulting payments, however, appear to be higher than expected. How do we get these future annuity payments in line with what we expect the annuity to pay out? 

A - When annuitising, there are two ways that the software can calculate future income from the funds: either specify what the annuity rate will be, yourself, or allow the software to derive an annuity rate based on the owner's age and gender. 

 

Option 1 - Specify the annuity rate

Where one has a reasonable idea of the applicable market (annuity) rate, taking account of the client's age and circumstances, etc., one can choose the option to 'Specify the Annuity Rate'. If chosen, the % entered is the straightforward 'Conversion Rate', i.e. the rate at which a lump sum converts into an annuity, e.g. a fund of £100,000 with a conversion rate of 5% will produce an annual income of £5,000.

(This option is probably what you should select, in this case).

 

Option 2 - Allow the software to derive an annuity rate (the software's default)

The software's default option, on the other hand, allows the software to 'derive' an annuity rate by using an 'Assumed Interest Rate' and it is for this 'assumed interest rate' that you have entered your figure of 2%.

The 'Assumed Interest Rate' on an annuity is the underlying interest rate assumption on which the annuity calculation is based (or would be based, by an actuary). It would ordinarily reflect an assumed yield on mid-dated UK Sovereign debt (Gilt yield).

 

We do not pretend to know what rate of interest would, in fact, give rise to a realistic annuity rate in today's marketplace. Secondly, the primary reason that the software defaults to using the 'assumed interest rate', in the first place, is because this option does take account of an individual's gender and age at the time the annuity is purchased. It will, therefore, give one a different result (other things being equal) when the client is 55 than it would when the same individual is 75 (for example).

In this instance, it is probably the 'Specify the Annuity Rate' option that you're looking for since you have a specific rate in mind. In the event that you decide to use the 'Assumed Interest Rate' option, we generally recommend that you should make allowances for provider costs / charges AND provider mortality assumptions. Therefore it generally makes sense to understate the expected yield.

 

Where to find these annuitisation settings in Voyant

Annutisation settings are found in three locations in the software, depending on what you plan to annuitise and the type of annuity. 

Money Purchases - Settings to schedule the future annuitisation of a money purchase are found on the Pensions > Money Purchase screen.

Expand Withdrawals & Annuity and select Annuity

  

 

Drawdown Pensions - Settings to schedule the future annuitisation of a drawdown pension are found on the Pensions > Drawdown Pension screen.

Expand Drawdown & Annuity and select Annuity

   

 

Future Non-Pension Annuities - The Pensions > Annuity screen is used to enter current annuities and to schedule the purchase of future non-pension annuities. The future annuitisation of money purchases or drawdown pensions are scheduled separately on those respective screens of the software. 

The annuity rate is set on this screen under Advanced Settings > Annuity Calculation Settings

The annuity rate is not used to calculate current annuity payments. If your client is already receiving annuity payments (the pension Status is In Payment or Deferred), payments will be based on the amount entered in the Payment field. 

  

 

Related topics

Default Inflation / Growth Rates - Assumed Annuity Interest Rate