If you’re planning to buy an annuity, it isn’t a case of ‘one size fits all’, so you’ll need to get to grips with the different types before you take the plunge.
An annuity is essentially a contract with an insurance company. In return for handing over some, or all your pension savings, you’ll be paid a guaranteed income for life, or a fixed term. The amount of income you’ll get will depend on a range of factors including how much of your pension you’re using to buy an annuity, how old you are, whether you want the income you get to increase each year, your health, and whether you want the annuity to pay out to your spouse, partner, or someone else after you die.
Different types of annuity
Here’s a rundown of some of the available annuity options. Remember that you don’t have to go for the annuity offered to you by your pension provider. In fact, it’s essential you compare annuities from a wide range of providers, as the rates (and therefore the retirement income) you’ll be offered can vary widely.
As its name suggests, a lifetime annuity will provide you with an income for the rest of your life. The income you’ll be offered will depend on your life expectancy and the expected returns the annuity provider thinks they can make from their investments (usually government bonds, otherwise known as gilts).
Joint life annuity
A joint life annuity is an annuity which pays you an income until you die, at which point it transfers to your partner or spouse and will pay them an income until they die.
Alternatively you can arrange it so that it pays a regular income to another beneficiary, such as a dependent child after you die – although in this case the annuity would typically only pay out until they reach a certain age, typically 23, at which stage they’ll hopefully be financially independent.
Temporary or fixed term annuity
When you take out a temporary or fixed term annuity, the income you receive will only be paid for a set period, for example, two or three years. The maximum length of time you can have a temporary annuity for is five years. Since you’ll only receive an income for a relatively short period of time, you’ll need to use less of your pension than you would if you wanted an income that lasts your lifetime. This type of annuity might suit someone who thinks their circumstances could change in future. For example, if you plan to downsize in a few years and release cash from your property, this may mean at that point you’d no longer need income from an annuity.
If you’re a smoker, are overweight, or there are other factors which might shorten your life expectancy, you might be eligible for an enhanced annuity. This type of annuity will typically offer you a higher income than other lifetime annuities, as the provider assumes that with a shorter expected lifespan, they will need to make payments for a shorter period of time.
Impaired life annuity
An impaired life annuity works in a similar way to an enhanced annuity, in that you’ll typically be offered a higher rate of income because your life expectancy is shorter due to a medical condition. For example, you may have diabetes or heart disease that may reduce your life expectancy. Before you’re offered an impaired life annuity, you’ll usually be required to complete a medical questionnaire, and some providers may require your medical records, or for you to undergo an examination.
When you buy an investment-linked annuity, you’re guaranteed to receive a minimum income, but the total amount you receive can vary depending on changes in the value of investments that your annuity is linked to. The advantage of this is that if the investments do well, your income could rise over time. However, if they underperform, your income could fall so if you’re considering this option, you’ll need to be comfortable accepting this risk. Depending on what your requirements are, following the pension freedoms, it’s worth considering that flexi-access drawdown (where you can take an income from your pension as and when you need it whilst leaving your savings invested) may be a more flexible way to take your retirement income, than an Investment-linked annuity.
Inflation or index-linked annuity
An inflation or index-linked annuity is designed to provide an income that will keep pace with rising living costs. The income you receive is typically linked to the Retail Prices Index, which is a measure of inflation that looks at the prices of consumer goods we spend our money on, such as food, drink, clothing and other essentials, and also includes housing costs such as mortgage interest payments and council tax. Initially your payments will typically be lower than the amount you’d get from a standard lifetime annuity (which provides a fixed level of income), but over time as inflation rises, the aim is that you should end up with a higher level of income.
How to get advice on an annuity
Buying an annuity is a significant financial decision that could have a long term impact on your retirement income. Not all providers will offer you the same monthly income from any given pot of money, so it’s crucial to shop around and get the best deal for your circumstances. It’s also important to note that since the pension reforms in 2015, you are no longer compelled to buy an annuity – so it may not be the best way for you to choose to take your retirement income.
If you aren’t sure which annuity to go for, or whether an annuity product is even right for you in the first place, always seek professional financial advice on your specific circumstances.
You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.
If you think you might be interested in speaking with a financial advisor, VouchedFor is currently offering Rest Less members a free pension check with a local well-rated financial advisor. There’s no obligation, but once you’ve had your check, the advisor will discuss the potential for an ongoing paid relationship if you think it might be useful to you.
Are you considering buying an annuity, or are you already taking an income from your pension? We’d be interested to hear your views. You can join the money conversation on the Rest Less community or leave a comment below.