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Annuities can provide you with a guaranteed income payable for either the rest of your life or a fixed number of years.

If you have a defined contribution pension scheme, you have a number of different choices when you decide to start drawing retirement benefits. One of these is to buy an annuity to provide you with a guaranteed income, either for the rest of your life (a lifetime annuity) or for a fixed number of years (a temporary annuity).

Remember, you don't have to buy an annuity to provide retirement benefits, but an annuity can help to provide certainty of income in the future. You can also build in a continuing income to a surviving dependant (such as your spouse) should you die.

You can also decide to use part of your pension pot to purchase an annuity and the rest to take as a tax-free cash lump sum (pension commencement lump sum (PCLS)) and/ or to provide an income in other ways (including taking some income as a lump sum).

Annuities are provided by insurance companies. There are different types of annuity available and each has a number of different options that you can select.

Some annuities may be more suitable than others for your particular circumstances. You may want to consider talking to a regulated financial adviser to help you choose the most suitable annuity.

How much you receive from an annuity

The amount of income that you will receive from an annuity depends on a number of different factors including:

  • Your age when the annuity starts
  • The term of the annuity (lifetime or temporary annuity)
  • The amount available to buy the annuity (the Purchase Price)
  • Interest rates and/ or anticipated future investment returns
  • The options you select to be included

Some providers may also take other factors, such as your state of health, whether you smoke and/ or where you live, into account when determining how much income they will offer you.

The amount of income that different providers will offer for a given purchase price can vary significantly, so you should always shop around  to make sure you’re getting the best deal. If you use a financial adviser, they can get you quotes from a number of different providers by just completing a single form. You can also consult annuity comparison services. Many of these are online, such as the Money Advice Service’s annuity comparison table, which you can access here.


What are the annuity options?

The options that you can select for an annuity include:

  • taking a tax-free cash lump sum (pension commencement lump sum (PCLS));
  • frequency of income payments – monthly, quarterly, half-yearly or annually;
  • payments in advance (i.e. paid at the start of the payment period) or in arrears (i.e. paid at the end of the payment period);
  • escalation – the rate of increase of income payments each year – to counter the effects of inflation. Level payments do not increase in payment or you can select for payments to increase each year in line with inflation (generally in line with the Retail Prices Index (RPI)) or at a fixed rate (e.g. 3.0% a year). The maximum fixed escalation rate is generally 8.5% a year;
  • guarantee period – this guarantees that income payments will be made for a minimum period of time, even if you die soon after purchasing the annuity. Since 2015 there is no maximum guarantee period although some providers go to a limit of 30 years. Typically the most common guarantee periods are 5 to 10 years. A capital protected annuity will pay out income (before tax) at least equal to the Purchase Price, even if you die soon after purchasing it;                                                                                                  
  • joint life last survivor annuity provides a continuing income for a nominated surviving dependant should you die. The continuing income is usually expressed as a percentage (1-100%) you choose of the income that you were receiving immediately before your death;
  • payments with or without Overlap – if you have selected a guarantee period and a continuing income to a dependant and you die within the guarantee period, both the remaining income payments and the dependant’s income payments will be paid if you select ‘with overlap’. If you select ‘without overlap’, the dependant’s income will not start until the remaining income payments over the guarantee period have finished;
  • payments with or without proportion – if ‘with proportion’ is selected and you die, a proportion of the next income payment due is paid based on the number of days since the last income payment and the date of your death.

Each option that is selected can reduce the starting amount of income that the annuity will provide, but some, such as escalation or joint life annuities may mean that more income is paid out over the lifetime of the annuity – this does, however, depend on how long you (and your nominated dependant, if applicable) live.

The income paid by an annuity is taxed as income. The annuity provider will usually deduct tax, using your tax code, before paying the net income to you. No National Insurance contributions are payable on income from annuities.


Changing annuity rates

Annuity rates, which determine how much income is paid for a given Purchase Price, change frequently, although if you receive a quotation for an annuity, the stated rate is usually guaranteed for a period to allow you to complete the purchase of the annuity.

Over recent years, annuity rates have fallen as we have moved into a low interest rate environment and annuities have, consequently, become less popular, although for many, they continue to provide a valuable foundation for providing retirement income. 


Frequently asked...

Where can I find out more?

If you need more information, please contact us. A pension specialist from our team will be happy to help with whatever pensions-related question you have. Our help is always free.

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