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Annuities

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Annuities explained

Image of Michelle Monck

Michelle Monck

Consumer Finance Expert

At a glance

  • You have the legal right to shop around when choosing an annuity and you will often get a better deal by comparing products
  • The older you are when you take your annuity the more income you will get
  • You can choose an annuity that provides the same income throughout your life or one that provides an income that increases in line with inflation

What is an annuity?

An annuity provides a guaranteed income throughout your retirement. You can use the money you have saved in a pension to purchase an annuity which will then provide you with a monthly, quarterly or annual income for the duration of your lifetime.


You can purchase an annuity from the age of 55 (increasing to 57 in 2028) and the amount of income you get will depend on how big your pension pot is, your health, age and if you choose to guarantee your income.


Choosing an annuity is one of the biggest financial decisions anyone will have to make, so getting it right is crucial. Make sure you consider all the options available to you regarding your pension income. Changes that came into effect in April 2015 give more flexibility on how you use your pension pot, such as pension drawdown.

What is a joint annuity?

A joint annuity is for two partners wanting to receive a guaranteed annuity payment until the last partner has died. This usually pays a lower income than a single annuity, especially if one partner is younger and/or healthier. It is also possible to include a guaranteed period with a joint annuity. This means that after one partner dies during the guarantee period their annuity payment will be transferred to their partner for the remainder of the guarantee period.


You can choose a joint annuity where the income of the deceased partner continues to be paid to the surviving partner but at a reduced rate. This means your initial joint income can be greater, while still retaining some additional income for the surviving partner.

How does an annuity work?

You can usually choose to take up to 25% as tax-free cash

At the point you decide to start taking your pension fund as income, you can usually choose to take up to 25% of your fund as a one-off payment, free of tax. Of course, you don’t have to take any at all if you prefer.


With some providers you can choose to take additional cash lump sums, however anything above this will be taxed at your marginal rate. But beware, the more you take out at this stage, the less you’ll receive in your regular payments.

Your health and lifestyle impacts your annuity income

Current and past health conditions and your lifestyle, as well as those of anyone who is named on the annuity, could significantly increase your annuity income. Providing as much detail as you can, from your postcode through to your lifestyle and medical history, could help you achieve more income during your retirement.

You can choose to protect your annuity income from inflation

You can choose for your income to remain at the same amount, as it was the day you set up the plan. Alternatively, you can choose for it to increase annually to offset the effects of inflation, however this will result in a lower starting income.

You can choose the frequency of your annuity payments

You can choose how often you want your annuity income to be paid. For example, you may want to receive it monthly or annually, or perhaps every six months? You can also choose whether you want to be paid in advance or arrears.

What are the different types of annuity?

Annuities offer different features that may be more suitable depending on your circumstances and needs.

What is an enhanced annuity?

An enhanced annuity can pay you a better income than a standard pension annuity, as it takes into account your lifestyle as well as your medical and occupational history. As your life expectancy could be reduced by your health and lifestyle, annuity providers calculate that they’ll have to pay you an income for a shorter amount of time, so can afford to pay you more during that period.


If you live longer, you’ll still receive the same heightened level of income – annuity payments are guaranteed for life, however long that may be.


Importantly, enhanced annuities are priced according to your individual specifications, so may consider some or all of these factors:

  • If you are overweight
  • If you smoke
  • Your previous occupation (if you have worked with asbestos for instance)
  • If you've had a previous or current health problem that could limit your life expectancy (such as a heart attack or high blood pressure)
  • Your postcode (life expectancy can vary quite a bit depending on where you live)

While all of this is unpleasant to think about, you may be able to secure a far higher retirement income by purchasing an enhanced annuity – as long as you are completely honest on your application. You don’t even need to have a serious medical condition to qualify. If you have any form of health or lifestyle condition that could impact your life expectancy, even something as simple as drinking alcohol, you could receive an increased income (though the level of uplift will depend on the severity of your condition).

What is an escalating annuity?

An escalating annuity starts with a lower regular annuity payment than a traditional annuity. Your income will increase every year either by a fixed rate selected at the point you take the annuity or by inflation. It will take quite a few years for an escalating annuity to 'catch up' with a traditional annuity.

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Unless you decide to go ahead, the service is completely free of charge, as the fixed advice fee of £1,295 would only be payable on completion of a plan.

Why take out a pension annuity?

A pension annuity is still the only product that will give you a guaranteed income for life paid regularly to you for the whole of your retirement.
You can also enjoy:

  • The reassurance of knowing exactly how much you can expect in each payment
  • Peace of mind that your income will continue exactly how you have set it up to – no matter what the stock market does
  • Flexibility to set up your annuity to meet your needs, whether that’s providing for loved ones following your death or keeping up with inflation
  • The ability to take up to 25% of the pension fund as tax-free cash

If you have a defined benefit or final salary pension, then this will provide you an income instead of an annuity.

What are the alternatives to an annuity?

There are alternative sources of retirement income to an annuity, these are:

  • Take small cash sums from your pension pot as and when needed
  • Take your whole pot as cash for future investment
  • Use your pot to provide a flexible retirement income also known as pension drawdown
  • Release equity in your home with a lifetime mortgage

It may not be possible to change annuity providers later and there may be tax implications from these choices, so it is recommended that you speak to an independent financial adviser. You can also try Pension Wise, a free and impartial government service that offers guidance to people approaching retirement.

Boosting your retirement income with equity release

If you are 55 or over and own your own home, you could consider using equity release to significantly boost your retirement income. Depending on your age, you can release up to 40% of the value of your home and continue to live there, usually without having to make any repayments.

What happens to my pension annuity when I die?

It is possible to buy an annuity and for your beneficiaries to benefit after your death. You can do this by buying an annuity with a guaranteed period or value protection. A joint annuity is also another way to make sure your partner continues to receive an income after your death.

What is an annuity guarantee period?

An annuity with a guarantee period allows your beneficiary to receive your annuity payments if you die before the guarantee period ends. Your beneficiary will receive this until the end of the guarantee period. Usually this is over five or 10 years, but some annuity providers will allow up to 30 years. If you die after the guarantee period has ended, then your annuity payment will stop. Although a short guarantee period has little impact on the amount you will receive, longer guarantees will result in a lower starting income.

What is an annuity with value protection?

An annuity with value protection pays out a lump sum to your beneficiaries if you die before a certain period. This is unlike a guarantee period that instead pays out the regular income of your annuity when you pass away before a certain time.

Is annuity income left to beneficiaries subject to tax?

Your beneficiaries will not have to pay tax on your annuity income if you die before your 75th birthday.

Annuity FAQs

Should I take an annuity from my pension provider?

Some pensions, particularly older ones, offer a Guaranteed Annuity Rate (GAR). A GAR may be quite a bit higher than those available on the open annuity market, particularly given that the average annuity income has dropped substantially over the last few years.

Why do annuities pay a higher income to older people?

The younger you are when you purchase your annuity, the less of an income you will get, as the provider will assume that they will have to pay you an income for a longer period.
Although you can purchase an annuity from the age of 55 (please note the government has confirmed this will change to age 57 from 2028), there is no requirement for you to actually retire when you start to receive your annuity income. When you purchase your annuity is up to you – just keep in mind that the older you are, the greater the annual income you are likely to receive.

Should you take the tax-free cash when purchasing an annuity?

Another option when you purchase your annuity is to take a portion of your pension pot (usually up to 25%) as a tax-free lump sum. Bear in mind, however, that any cash you take from your pension will reduce the amount you have left to buy an annuity with. This would mean a lower income in retirement. The decision to take tax-free cash will be based on your circumstances and objectives. You may wish to pay off a debt, gift money to family, make home improvements, take a holiday or spend a lump sum on something else.
If you are in any doubt over whether to withdraw some of this cash, you should seek professional advice.

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Note

The Equity Release Service is provided by Mortgage Advice Bureau Later Life. Mortgage Advice Bureau Later Life is a trading name of Key Retirement Solutions Ltd. Registered office: Baines House, 4 Midgery Court, Fulwood, Preston, Lancs PR2 9ZH. Registered in England No.02457440. Key Retirement Solutions is authorised and regulated by the Financial Conduct Authority.

 

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Moneyfactscompare.co.uk will never contact you by phone to sell you any financial product. Any calls like this are not from Moneyfacts. Emails sent by Moneyfactscompare.co.uk will always be from news@moneyfacts-news.co.uk. Be ScamSmart.

Moneyfactscompare.co.uk will never contact you by phone to sell you any financial product. Any calls like this are not from Moneyfacts. Emails sent by Moneyfactscompare.co.uk will always be from news@moneyfacts-news.co.uk. Be ScamSmart.