Buying an annuity: How to shop around
Types of annuity
It’s important to understand the different types of annuity that are available to ensure you make the right choice. It’s also important to remember that buying an annuity is not the only choice available to you.
Types of annuity
When you purchase an annuity, it’s important that you buy the right annuity and you include the right options in the annuity for your personal circumstances.
Once an annuity has been set up, it can be very difficult and often impossible to change it. It’s therefore important that you give it plenty of thought beforehand, as you could be making an irreversible decision.
There are different types of annuity available, which provide different levels of income for you and possibly for your dependants. The level of income offered by a particular type of annuity will depend on the provider that you use and the options that you select. If you’re not sure whether a particular annuity may be suitable, you may want to seek further advice. We are happy to help you, but please note that we can’t provide specific financial advice. An independent financial adviser may be able to help if you need someone to recommend a definitive course of action.
The Government is currently carrying out a consultation on the annuity market and this could result in changes in the future, but such changes may not apply to those already receiving income from annuities.
Since 6 April 2006, it has not been compulsory to purchase an annuity with the proceeds from a defined contribution pension pot. However, buying an annuity at retirement or at some point during retirement may be the best route for you.
The different types of annuity that are available today include:
These are the most common type of pension annuity (also known as compulsory purchase annuities or just as annuities). A lifetime annuity provides an income stream for the rest of your life (as the annuitant) or the rest of the lives of the annuitants for a joint life last survivor annuity. The annuity rate is the amount of income that you will be offered for each £ of pension fund. The rate offered is based on the average life expectancy for people your age and the investment returns for the low risk investments that the insurance company will invest your money in.
These are a type of lifetime annuity offered by some insurance companies/annuity providers. An enhanced annuity may offer a higher annuity rate (and therefore a higher income) than a lifetime annuity, if you meet certain criteria which could shorten your life expectancy. These criteria include:
- you are, or have been, a smoker; and/ or
- you are overweight; and/ or
- you have spent a significant part of your working life in a hazardous environment.
You may be asked additional questions before you are offered an enhanced annuity rate. The annuity rate that you are offered is based on the average life expectancy for people meeting the above criteria.
Impaired life annuities
These are a type of lifetime annuity offered by some insurance companies/annuity providers that are designed for people that suffer from, or have suffered from, a medical condition that results in a reduced life expectancy. To qualify for an impaired life annuity, you will need to complete a questionnaire on your medical history. The annuity provider may also ask for further information from your doctor and/ or ask you to attend a medical examination. The annuity rate that you’re offered is based on an estimate of your personal life expectancy calculated using the medical information supplied.
These are a type of lifetime annuity offered by some insurance companies/annuity providers where they base the annuity rate they offer on where you live. The thinking behind this is that people living in different parts of the country have different life expectancies – broadly speaking, if you live in a wealthier area, you’re likely to live longer than someone living in a poorer part of the country. If you’re likely to live for longer, the annuity will be paid for longer so you’re likely to be offered a lower annuity rate.
These are a type of annuity that only pay income for a fixed term or until you die, if earlier. The maximum term for a temporary annuity is 5 years. They may be useful if you need income today but don’t want to commit to a lifetime annuity yet. A temporary annuity is likely to offer a far higher annuity rate than an equivalent lifetime annuity as the period over which the annuity will be paid is likely to be shorter. This means that you would need to use less of your pension pot to secure a specific level of income (but this income would cease at the end of the term).
These are a type of lifetime annuity where part of the income is guaranteed and part is linked to investment performance. You select the guaranteed level of income that you want and part of your pension fund is used to provide this. The balance of the fund is invested and pays additional income based on the investment returns received. You would receive higher levels of income if investment markets are performing well, but could only receive the minimum guaranteed amount if markets are falling. Investment-linked annuities are, in effect, a halfway house between a conventional lifetime annuity and income drawdown.
Purchased life annuities (PLAs)
PLAs are a type of annuity that are purchased with money that is not in your pension pot (although they can be purchased with your pension commencement lump sum (PCLS) once you have taken it, as it has then left your pension pot.
A lifetime PLA can provide income for the rest of your life (and that of a surviving dependant) or a temporary PLA for a fixed number of years or your death if earlier. PLAs have the same options as pension annuities, although they are treated slightly differently for tax purposes – part of each income payment is treated as return of the initial capital invested and, as such, is not subject to income tax. The amount of this return of capital (the capital content) depends on your age when you purchased the PLA. They may also be written on a capital protected basis, which means that they will always pay out at least as much income (before tax) as the amounted invested as the Purchase Price.
As discussed earlier, the design of annuities may be changing, following the Government’s consultations. We will update this page as and when we have more information about the possible changes.
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.