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Annuities are critical

    Falling stock markets, low interest rates and high inflation are a huge headache for anyone approaching retirement.

    Many people have seen a 15 per cent fall in their forecast retirement income in recent weeks. A major cause of this pension shortfall is the rising cost of buying annuities - which is the most common way of taking a pension income from your pension fund.

    So how do annuities work?

    An insurance company takes your pension fund and, in exchange, promises to pay you a specified pension income, usually for the rest of your life.

    Your pension company will write to you a few months before your expected retirement date, offering you a standard annuity.

    Your pension company may give a very poor rate

    Make sure you don't just take their offer without checking it is right for you. Once an annuity has been bought, you can never change it, so it is vital to understand what you are doing before making this irreversible decision.

    Your pension company may give you a very poor annuity rate, and it could be offering you the wrong kind of annuity altogether.

    It's really worth getting financial advice before you buy, because your pension company will deduct up to 2 per cent of your fund as 'commission' anyway. If this is not paid to your adviser, the insurer just pockets that money, so you might as well take advice.

    There are a few vital questions to consider before buying.

    First, your insurer's standard 'single life' annuity may not be right for you. If you are married, you may need a 'joint life' annuity, which continues paying your spouse if you die early. You may also want some protection against inflation.If you smoke or have health problems, including diabetes, high blood pressure or cholesterol, you could qualify for an 'enhanced annuity rate' giving higher pension income, but you may need help to find the best rates.

    Rather than just a standard five-year guarantee, you could consider a ten-year guarantee, or even a 'money-back guarantee', called a 'value protected annuity', which would ensure that, if you die early, any money from your original pension fund that has not already been paid to you as income, will be paid into your estate, subject to a tax charge.

    Finally, you may not need an annuity immediately and could wait for markets to recover, by taking some tax-free cash and leaving the rest of your pension money invested or buying a fixed-term, rather than lifelong annuity.

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