Updated: April 16, 2024
A Guide to Annuities
Thinking of buying an annuity with your pension? Here is the key information you need to know
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To provide a simple explanation and definition of pension annuities along with the key information you need to know, we’ve put together this comprehensive UK annuities guide which covers:
If you have any questions on UK annuities, make an enquiry and we can arrange for an expert to contact you directly.
They can explain what annuities are and provide you with a 2020 annuity revenue example based on your circumstances and finances.
What is an annuity?
An annuity is a retirement product you can purchase with some or the entirety of your pension pot.
When purchasing annuities, you are making an agreement with the annuity provider that they will pay you a regular retirement income either for the rest of your life or for a fixed period.
The amount that you will receive in payouts is based on many factors but predominantly, your life expectancy, health and the amount you deposit, will determine this.
Depending on the type of annuity that is purchased and the terms set out in the contract, the annuity provider may also be contractually obliged to pay out for other assurances such as principal protection, lifetime income, legacy planning or long-term care costs.
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How do annuities work?
A lot of people approaching retirement worry about the risk of outliving their pension income
Purchasing annuities secures them a guaranteed income, meaning that they don’t have to worry about their funds ever running out.
However, there are many variations of annuity products, each with their own features and benefits including:
- Lifetime annuities – These provide a fixed income for the rest of your life
- Enhanced annuities– You may have to meet certain eligibility requirements for this type of annuity as these can pay out higher income
- With profit annuities – The income received from this type of annuity is linked directly to how well the investment strategy of the annuity provider performs.
- Deferred annuities– This product is also investment linked with the difference being that any funds are left untouched by the account holder until an agreed period of time has passed. During this time, referred to as the accumulation phase, any funds within the account are exempt from tax.
To learn more about the range of annuity products or to discuss which may be more beneficial for you, speak to an advisor.
What factors can affect the annuity rate?
To determine the rate and therefore the minimum income that they will pay out throughout the agreement, the annuity provider may ask questions about the buyer’s personal circumstances.
Factors that can affect the rate offered by an annuity provider include:
- Health – Those with health issues can usually expect higher payments, especially if their health is likely to reduce their life expectancy.
- Age – Annuity providers usually pay out higher rates for older buyers who may not be expected to live as long.
- The amount of money they deposit – Usually the more money put into the account, the higher the income.
- The length of time the payments are guaranteed for – Some annuity buyers opt for shorter agreements and therefore larger payments whilst others prefer an agreement which pays out an income until they die.
How often do you receive income from an annuity?
The annuity payments you receive can be paid weekly, monthly, quarterly, yearly, or at any other regular interval of time.
The frequency of your payments will differ depending on the type of annuity you have purchased as well as the terms and conditions set out in your annuity policy.
What is an annuity policy?
This refers to the agreement you make with the annuity provider.
Things that should be set out in your annuity policy include:
- The end date (if the contract is fixed)
- Information about any fees including exit charges
- Any restrictions
- Details about how often you will receive your income
- Your beneficiary names (if applicable)
- The minimum income you will receive
It can be beneficial to seek the advice of an annuities professional who can thoroughly examine your annuity contract on your behalf.
This can help to avoid any unexpected penalty fees or misunderstandings about the terms that you and your annuity provider will be obliged to follow.
Contact an advisor for more information.
What happens at the end of my policy agreement?
There are some agreements that have a fixed period on them, which means that after that period has passed, say for example, 10 years, the agreement stops.
If you join a plan that has no fixed term, then the annuity plan will pay out a retirement income until the end of your life (if you have a single annuity) or until your beneficiary dies (if you have a joint annuity agreement).
How do annuities work at death?
Ahead of signing your annuity contract, you will be asked to decide whether you would like a single or joint plan.
If you decide to opt for a single annuity plan with no added features, when you die payments stop and the contract ends.
This means that your beneficiaries will not receive any payments from the fund unless you opt for a value protected annuity, which is sometimes referred to as a ‘capital protected’ annuity.
You may find that the minimum income payments are higher with a single annuity plan.
This is because in the event of your death payments stop, whereas with a joint annuity plan, payments continue to be paid to a named beneficiary and therefore the annuity provider may end up paying out more overall.
This option appeals to many who wish to leave their family some inheritance.
What is a capital protected annuity?
If you take out a joint value protected annuity (or a capital protected annuity), a lump sum will be paid to your beneficiary tax free, when you die.
The only exception to this is that if you die aged 75 or over, income from a joint plan will be added to your beneficiary’s other income sources and taxed as normal.
This option can appeal to those who wish to leave their family some inheritance.
Do I need annuity protection?
Annuity protection can be used to protect the value of your annuities in the event that you die shortly after signing the agreement.
With annuity protection, a lump sum may become payable to your beneficiaries if you die before reaching age 75.
To work out the maximum lump sum that most insurers will pay out if you had 100% capital annuity protection, deduct the total amount of income paid to you until the point of death from the purchase price.
Here’s an example:
Purchase price of annuity = £100,000
Total amount of income paid during the agreement = £20,000
£100,000 – £20,000 = £80,000
How do annuities work after divorce?
In the event that you and your partner divorce, your annuities may be split evenly, particularly if both parties made financial contributions into the account in order to buy the annuity product.
The process of dividing annuities can be smoother if the account is joint, however, doing so could breach the terms of your annuity contract as the funds in the account may need to be withdrawn ahead of the agreed contract end date.
This could result in you and your ex-spouse having to pay penalty charges, also referred to as exit fees.
Another factor to consider is that withdrawing your annuities may affect how much income tax you pay.
Depending on your situation it may be more financially viable to transfer your annuities to another account.
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What are the annuity requirements?
Some pension providers and insurance companies have eligibility requirements that you must meet to qualify for their annuity products and they can include…
- Age restrictions: Some providers state that you must be between age 55 and 75 at entry, although others will allow you to purchase an annuity in advance of your retirement so you can access your funds from age 55.
- Minimum pension fund requirements: Some providers will only sell you an annuity if your fund is worth at least £10,000 exclusing any tax-free cash.
- Location restrictions: You wil usually need to be a resident of the UK and Northern Ireland. Keep in mind that some providers won’t sell an annuity to customers based in the Channel Islands or Isle of Man.
- Additional requirements for specific annuity types: For example, enhanced annuities are only available to customers with lower life expectancy.
Furthermore, annuity contracts can have terms that require the buyer to pay high charges such as exit fees. These charges can often be higher than other personal or stakeholder pensions, so they’re usually aimed at high net worth individuals and investors.
Is pension drawdown better than an annuity?
When you reach retirement age, you have three choices.
You can either:
- Purchase an annuity which will provide you with a regular income throughout your retirement
- Withdraw or transfer your pension to a scheme with Pension Freedoms facilities
- Keep your funds in your retirement pot and withdraw money as and when you need it, assuming your scheme has Pension Freedoms facilities
The idea of purchasing annuities doesn’t appeal to all retirees and some prefer to keep their pension in their pot and then manage their own income.
By doing this, they can withdraw their funds when they need it and leave the remaining balance in the account which can grow over time as it remains invested.
A downside to taking an annuity over income drawdown that some providers limit the amount of withdrawals per year and can even charge account holders a fee for going over this limit.
Another factor to consider is that if your pension pot is part of an investment strategy, your funds can increase and decrease over time. This of course, comes with a risk.
Which should I choose?
Unlike annuity products which have a minimum guaranteed income for as long as you live, once your funds run out from your annuity drawdown plan, your income stops.
This can leave many retirees with no income for their retirement, so this option, like any investment route, comes with risks.
Whether or not this type of plan is better than any other annuity plan, is completely dependent on your own circumstances and preferences.
To discuss whether an annuity or a drawdown plan is more suitable for your retirement income, speak to a professional.
Is there a drawdown calculator I can use?
Online calculators can be helpful if you would like a quick snapshot comparison between products. You can find a basic one on the government’s PensionWise website.
However, to make an informed decision, speak to a pensions professional. They will have current knowledge of each of the annuity product providers and the interest rates that they may offer you.
Every provider will also offer varying terms and penalty charges which can also affect the amount of income you withdraw once your annuities mature.
Once a pension professional has sourced the rates that may be available to you, they can look at your circumstances and calculate your income with an annuity drawdown plan versus any other annuity product.
Any purchase of an annuity product is a huge financial decision that could drastically affect your future retirement income.
Therefore it is always advisable to seek the advice of an expert who can guide you through the process.
Should I seek advice?
With such a range of retirement annuities plans and so many variables that can affect the amount of retirement income you can receive, the decision on whether or not to buy them can be confusing.
For clarity and for confidence in your annuities for retirement purchasing decision, speak to a professional who has experience with the full range of annuities products.
The advisors we work with can explain your options and provide detailed information about which avenue may be more suitable or beneficial for your circumstances.
Speak to an advisor
For free and confidential advice about annuities in retirement, call on 0808 189 0463.
Alternatively, make an enquiry and a member of the team will be in touch shortly to help you with any questions you may have or to provide you with an annuities quote.
FAQs
A temporary annuity is an annuity that only pays out for a fixed term. The period of time that the contract lasts is agreed at the beginning of the arrangement.
When this term has passed, the payment stops and you can either buy another annuity product or withdraw the funds and use them for your retirement income.
Unlike pensions, annuities can usually not be consolidated and are exempt from creditors.
This means that any funds within the account cannot be taken away by credit agencies in order to resolve debts.
It may also be possible to include annuity asset protection within your agreement so check with your provider before signing a contract if this is something you are interested in.
This is a term used when referring to the revenue paid out throughout the annuity agreement.
The annuity revenue of one investor could be paid out in regular intervals, perhaps monthly, whereas another investor could have an agreement to defer their payments for tax benefits.
How often payments are received depends on the type of annuity product you opt for and the agreement you make with the annuity provider ahead of signing.
Annuity cash flow refers to the stream of income paid out by an annuity. The cash flow may consist of a predictable minimum payout each month as well as any interest the account pays out.
Because of the unpredictable nature of most annuity products, annuity cash flows can increase or decrease from month to month, depending on how well the investment performs.
Some annuity providers may agree to pay out an annuity cash advance in the event that the account holder wishes to sell their annuities or access cash ahead of their contract end date.
This is because some annuity agreements contained ‘loopholes’ which enable over-55s to cash in their annuities if they are worth less than £10,000.
However, in some cases it can be rare for an annuity provider to agree to payout an annuity cash advance.
Many insurance companies reject applications of this nature so despite this ‘loophole’, it can be difficult to receive a payout.
If you would like to know whether your annuity provider will consider giving you an annuity cash advance, speak to an advisor who can use an annuity checker.
A compulsory annuity is another name for a guaranteed life annuity and is one of the many products that may be available to you from the annuities range.
This type of annuity provides regular income throughout your retirement and therefore the rest of your life.
Depending on the terms of your agreement, you may find that your annuity policy can also provide a pension for your spouse or dependant(s) after you die.
An annuity compound is an annuity that accumulates interest throughout the duration of the agreement. The interest made is then added to the total value of the annuity and reinvested which is why it is sometimes referred to as an accumulation annuity.
Accumulation annuity in practise…
For example, your initial investment is £5,000.
The rate of interest you are paid is 3% and this is paid yearly.
£5000 x 0.03 (3%) = £5,150
This amount is the new sum that is reinvested next year and then the annuities continuously compound over the duration of the agreement.
This is the date that your annuity contract will end. At this point you will be left with a total sum which can then be withdrawn or can be used to buy another annuity product.
We say that the annuity has matured because it has reached its final total.
If the annuity policy holder dies and they have named a beneficiary, then this person will inherit the annuities in the account.
However, the amount of payments that the beneficiary receives can be affected by the type of annuity purchased and the terms of the agreement. For example, if the policy included a death benefit clause.
Another point to note is that receiving annuity inheritance can affect how much tax the beneficiary pays as any annuity pension funds inherited will be classed as income.
It can be helpful to seek the advice of a financial expert as well as a pensions advisor, as they may be able to help explore other avenues such as reinvesting the annuities to avoid paying income tax.
Ask a quick question
We can help! We know everyone's circumstances are different, that's why we work with brokers who are experts in pensions Ask us a question and we'll get the best expert to help.
Tony Stevens
Finance Expert
About the author
Tony has worked in a vastly diverse array of areas in the pensions industry for over 20 years. Tony regularly writes for trade press, usually on topical and pensions pieces as well as acting as a judge at prestigious national events.
Tony is also a highly qualified Independent Financial Adviser in his own right. His mantra has always been “Hope for the best, but plan for the worst”, and believes that the biggest impact that an adviser can have on a client’s life journey is to take them on a journey from generally having little or no real idea of what their retirement will look like, to giving them the understanding of what their retirement looks like now, then helping them navigate a path to what they want their retirement to be.
