What is a pension annuity
Annuities convert your pension savings into an income for the rest of your life.
You’ve spent years putting money aside into a pension, but what actually happens once you retire?
Sadly, it’s not as simple as just withdrawing the money at present. However, from April 2015 onwards you’ll be able to withdraw as much of the money as you want when you reach 55, although it will be taxed as income.
So, what is an annuity and how do they work? This guide explains the basics of the products and the pros and cons of buying one. What is an annuity?
What is an annuity
An annuity is a financial product that allows you to convert your pension savings into a regular income that will last you for the rest of your life.
When you get a quote for an annuity, you’ll be given a rate as a percentage. You’ll need to multiply by your pension savings to calculate how much income you’ll get every year.
So, if you have £100,000 in your pension pot, and are offered an annuity rate of 6%, you’ll get an annual income of £6,000 a year.
Go further: Annuity Rates – Understand how annuity rates are calculated and how they differ.
What are the different types of annuity?
There are a variety of annuities for you to choose from that are suited to your and your partner’s needs.
- Single life annuities – all the income is paid to you
- Joint life annuities – some or all of your income is paid to your partner after you die
- Escalating annuities – your income rises every year, by a fixed rate or by the rate of inflation
- Standard annuities – these generally offer the starting annuity rates from limited number of annuity providers
- Lifestyle annuities – these pay more than Standard annuities by looking at how you have lived and currently live your life
- Enhanced (Impaired Life) annuities – these pay you more income if you have a medical condition
- Investment annuities – your money remains invested with the potential for higher income
- Flexible annuities – these are complex products that pay you a guaranteed income but leave the potential for your money to grow by keeping part invested
- Fixed-term annuities – these pay out for a fixed period, after which you get paid a lump sum
Go further: Annuity Options – find out more about the different types of annuity in our handy guide.
Who can buy an annuity?
You can only buy an annuity if you have a defined contribution workplace pension or a personal pension – defined benefit or final salary pensions pay you an income directly, so there’s no need to buy an annuity.
With some workplace pension schemes, the pension trustees – the people looking after your pension savings – may buy an annuity for you. Find out what your options are from your scheme manager.
What are the benefits of annuities?
One of the key benefits of an annuity is that your income will be guaranteed – you’ll receive a fixed regular payment each year until you die. Your retirement income won’t be subject to stock market fluctuations either (unless you select an investment-linked annuity).
Keep up with rising prices
You can also choose annuities that will increase in value every year in line with inflation. This will ensure that your money in older age keeps up with the rising prices of goods, giving you a comfortable retirement.
Get paid more for being poorly
If you have poor health, enhanced (or impaired) annuities pay out a higher income than standard annuities – as much as 65% more – because the insurer will have to pay out for a shorter amount of time due to your decreased life expectancy.
What are the downsides of annuities?
You can’t change your mind
The biggest downside of buying an annuity is that the decision is irreversible. You can’t ‘switch’ annuity providers for a better deal, like you can with insurance or bank accounts. This means that you have to get the decision right first time. Following the Budget 2015, the option to sell your annuity is under consultation, more information will follow in due course.
You can’t leave anything behind
If you’ve used all your pension savings to buy an annuity, you won’t be able to leave any behind to your family when you die – even if you haven’t been paid back all that you put in. (you can choose a joint life annuity to provide your spouse a percentage of your income if they outlive you. Alternatively, you can include a guarantee period or value protection which could pay back money if you die. See our Annuity Options page for further information.)
It all goes to the annuity provider – this ‘cross subsidy’ exists so that people who die younger pay for people who live longer and end up getting paid more income than they put in.
Rates fluctuate all the time
Annuity rates aren’t just based on your personal circumstances – they’re also based on the investments annuity providers use to fund the products. If these are performing poorly at the time when you retire, you may get a lower rate. Rates are also getting lower because providers have to account for people living for longer.
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