What is an annuity?
Key facts
- Annuities are guaranteed and will either pay an income for the rest of the owner's life - known as a lifetime annuity - or for a set number of years, known as a fixed term annuity.
- Once set up an annuity can't be changed, so it's important to ensure that it's structured correctly.
- Annuities can provide a level income that never changes, or an income that goes up each year by an agreed amount.
- The amount of income an annuity will provide is based on a number of factors, including the amount of money, the applicant's age and health and any features selected.
- You can take up to 25% of your pension fund as a tax free lump sum and use the rest to buy an annuity.
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What you need
Key themes at a glance
Open Market
Guaranteed Income
Tax
What is an annuity?
An annuity is a financial contract between you and an insurance company. Here’s how it works:
1. You make a lump-sum payment (i.e. your pension savings) to an insurance company.
2. In return, you receive regular income. These payments can begin immediately or at a specified future date.
There are different types of annuities, each with its own features:
- Lifetime annuities: these provide an income for the rest of your life.
- Level annuities: pay the same income each year, but will not adjust for inflation.
- Inflation-linked annuities: increase each year to protect against inflation.
- Enhanced annuities: pay higher income based on your health or lifestyle.
- Joint Life Annuities: continue to pay an income to your spouse or partner after your death.
Remember that annuity contracts vary, so it’s essential to consider your specific circumstances when making decisions about annuities.
Watch our short video on annuities to find out more.
The good things about annuities
Choice and personalisation
You can tailor your annuity income to your personal circumstances. There are lots of choices for tailoring your income, such as:
- yearly increases, fixed or in line with inflation
- a pension for someone close to you if you die before them
- a guarantee that the income will continue for a certain time, even if you die during that time, and
- value protection, where you protect part or all of your pension savings as an amount to be paid to your beneficiaries - then, after you die, your annuity provider takes off the income you’ve received and, if there’s any money left, pays it to your beneficiaries.
If you have a health condition that could shorten your life, your medical information could potentially get you a higher income.
Be aware, the more features you add the lower the starting income will be.
Simplicity
Once the annuity is set up there's nothing else to do - you can just sit back and spend the money.
Not-so-good things about annuities
Lack of flexibility
Once an annuity has been set up it can't be changed, so it's important to get it right in the first place.
The income can stop when you die
Depending on what kind of annuity you choose, the income can stop completely when you die, with nothing left over. You can choose an annuity that pays a pension to someone close to you, but that will stop when they die. Or you can choose value protection, where you protect part or all of your pension savings as an amount to be paid to your beneficiaries when you die – so they get this amount, less the pension payments you’d already received.
Potential lack of value
The amount of yearly income you’ll get from an annuity can look low compared to the amount in your pension pot. But remember: the income is paid for the rest of your life (or a fixed time). If you multiply your annuity by an estimate of the number of years you expect to live, it could look quite different.
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