An You can usually withdraw 25% of your fund as a tax free lump sum thereafter an annuity will pay you a taxable income for the rest of your life. Annuities are provided by insurance companies. The company that you choose promises to pay you a regular income in exchange for your pension fund, no matter how long you live.

Once set up, the terms of your Annuity tend to be fixed and offers a secure income. You can rest safe in the knowledge that your income will never run out. However, because the income is fixed it is important to choose your options very carefully, because once it is set up you cannot change your mind.

The Open Market Option – your right to shop around

You do not have to stay with your existing pension provider when you retire and often they will not offer you the best annuity income – Like Banks they rarely offer their existing customers the best rates and the difference between the best and worst annuity rates can be substantial.

You can get more from an annuity if you shop around. You may qualify for what is known as an Enhanced Annuity (sometimes known as an Impaired Life Annuity). This pays a higher income to people who suffer from a range of health conditions – anything from asthma to heart disease, cancer or stroke or if you smoke. Additionally, higher rates are sometimes offered to people who have retired from certain occupations or people who live in certain parts of the country.

When setting up your annuity the choices you make are important and cannot usually be changed once it is set up. You should consider both your immediate and long-term needs carefully when making your decisions as well as those of any dependents.

What is an Annuity?

Confusingly, an annuity is what many people would think of as a ‘pension’ – it pays you a regular income. You can buy an annuity with any cash lump sum, but on this website we are only looking at conventional pension annuities. The concept of annuities is that you exchange a lump sum (in this case, your pension fund) for a guaranteed income for the rest of your life. Once you have purchased the annuity it cannot be altered or converted back into a lump sum. This is why it is so important to make the right decisions – you only get one chance. The benefit of doing this is that you have no further worries about investment risk. Annuity income is fixed for life.

How are Annuity rates calculated?

The annuity rate is the rate the insurance company uses to determine how much income they will pay you in exchange for your pension pot. If you have a pension pot of £100,000 and they exchange it for an income of £6,000 per year gross, this represents an annuity rate of 6%. One factor determining what annuity rate you get is their estimation of your mortality – how long you will live. This means that annuity rates for women are lower than those for men (because women on average live longer). Annuity rates are also lower for younger people, for the same reason. Conversely, if you have health problems or you are a smoker you can get an enhanced annuity rate based on your lower life expectancy. Because people are generally living longer due to improvements in medicine, there is an ongoing downward pressure on annuity rates which is likely to continue.

When can I buy an annuity?

You can currently buy an annuity with your pension fund from age 55.

What is a guaranteed period?

As it sounds, this is a time period within which your annuity will continue to be paid, even if you die prematurely. So a 5 year guaranteed period will ensure 5 years’ worth of annuity payments. After the guaranteed period ends, the annuity will still continue to pay until the annuitant dies. The possible maximum guaranteed period is 10 years. For all but the most elderly, this is a relatively inexpensive option to add to your annuity, and it will ensure that your surviving family would continue to benefit from your pension if you died prematurely.

What is a spouse’s pension?

This ensures that your surviving spouse would continue to receive income from your pension after your death for the remainder of their life. Spouse’s pensions are commonly selected as 50%, 66% or 100% of the original pension. The cost of a spouse’s pension varies, and is dependent on the relative ages of the two annuitants. If you combine a spouse’s pension and a guaranteed period and the annuitant dies within the guaranteed period, the spouse would get the full pension for the rest of that period and then the reduced spouse’s pension would commence.

What is escalation?

This is a term for a pension which increases each year, to combat the effects of inflation and to maintain the buying power of your pension. You can ask for your pension to increase in line with the Retail Price Index (RPI) each year, or at a fixed rate (3% or 5% each year are the most common). The problem with an increasing pension is that it drastically reduces your initial annuity payments in comparison with a level annuity. For a 3% increasing annuity, you would currently have to survive for at least 15 years before your increasing annuity had caught up with the income you would have received from a level pension.

How often will my pension be paid?

You can usually specify that your pension be paid monthly (the most popular), quarterly, half yearly or annually. The payments can be in advance (with the first payment coming immediately the annuity starts) or in arrears (monthly in arrears would start after 1 month).

What is an enhanced annuity?

Certain people can get a better annuity rate from specialist annuity providers based on their state of health. The logic is simple – if you are in less than perfect health then you are not likely to live as long so the company will offer a better annuity rate for you, even those with minor conditions like high blood pressure, obesity, or high cholesterol can get a better rate. The downside of this for healthy annuitants is that it will tend to drive down annuity rates for them.

Should I buy an Investment-linked Annuity?

Investment-linked annuities put your pension fund into investments, such as stocks and shares. This means you could continue to benefit from stockmarket investments after retirement, but there is also the risk that the value of your investments could fall.

Investment-linked annuities can either be:

with-profits – these link your income directly to the performance of the insurance company’s with-profits fund; or
unit-linked – these link your income to the funds you invest in.

Investment annuities usually have higher charges than basic annuities so bear in mind this could reduce your income in retirement. You should get specialist financial advice if you are considering an investment annuity.

What is Annuity protection lump sum death benefit ?

An annuity protection lump sum death benefit is another way of protecting your annuity if you die before age 75. A lump sum equivalent to the amount used to buy an annuity, less any income you have received, will be paid to your estate or beneficiaries on death.

An annuity with a guarantee or an annuity with a lump sum death benefit will be more expensive than a conventional annuity, so the income you will get will be lower.

Types of retirement options

After taking any lump sum, there are a number of ways to take an income from your money purchase pension. Some may only be suitable if you have a large pension fund or other substantial assets and you are prepared to take some risks with your pension fund to get greater flexibility and a potentially higher return.
Your options include:

A Lifetime Annuity

An Unsecured Pension (Flexi Access Drawdown)

Phased Retirement using a combination of Drawdown & Annuities

What if my pension funds are small?

If the total of all your pension funds is less than a minimum amount, you can take some or all of your pensions as a cash lump sum, rather than taking an income. This is known as trivial commutation.

You must be between at least 60 but not yet reached 75 and all the pension funds which you want to “commute” must be converted to cash within a 12-month period.

A quarter of the money you will get is tax free and the rest will be taxed as income.

You don’t have to “commute” all your pension funds, but bear in mind that it might be difficult to get a retirement income from small funds because many annuity providers will not take funds below a specified minimum, say £10,000.

What if I have more than one Pension fund?

If you are using more than one pension fund to buy an annuity, think about combining them when you are shopping around. You may get a better annuity rate from a larger fund.

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