An Annuity is a financial product that you buy with part or all of your pension pot. Once purchased the annuity pays out a regular, guaranteed amount for a set period of time (usually until death). In short you exchange a lump sum amount from your pension pot in exchange for an ongoing regular payment.
How does an Annuity work? As a very simple example, you could trade £100,000 of your pension pot in exchange for an annuity which pays you £4,000 every year for the rest of your life. These figures are made up for this simple example and as we will see there are many factors that can determine how much you will get in exchange for your lump sum payment, including the features you may want (such as the payment increasing with inflation) and your personal situation (such as your age, health etc).
No! You no longer have to get an annuity. Historically this was the case but hasn’t been so for several years. Since no longer being compulsory, annuity’s have become less popular, although they are still an important part of planning for retirement and often form part of a pension or retirement plan. So although it is no longer a requirement to purchase an annuity, they should certainly be considered alongside other products when working on your retirement plan.
Some pensions may pay out a guaranteed pension income which seems similar to an annuity (as it does the same job; provide a regular guaranteed payment) but is technically different with different rules applying to these payments. If you are unsure contact your pension provider or a pension adviser to make sure; many advisers (like ourselves) are usually happy to answer general questions you may have for no charge.
Purchasing Annuities are rarely the first choice when it comes to pension and retirement planning these days. This is less to do with the fading attractiveness of annuities and more to do with Pension Freedoms which gives everyone much more choice when it came to what do with their pension pot.
The other main option for taking income from your pension pot is called “Drawdown”. Drawdown broadly involves taking money from your pension pot as and when needed, and keeping the rest invested. Drawdown comes with a lot more flexibility and there are a variety of options in how it can be managed, but it does not come with the certainty of income that you can get with an annuity.
Another option for drawing funds from your Defined Contribution pension is to withdraw lump sums as and when they are required. A lump sum is simply a chunk of cash which you take out of your pension pot. Part or all of this may be tax free with the rest having income tax payable. Withdrawing funds in this way can be convenient but also may have consequences that need to be taken into account, such as triggering a reduction in your annual allowance or an increase in tax.
There are other ways of withdrawing funds from a defined contribution pension and its likely that the most efficient way will involve a combination of several options.
Moving some or all of your pension pot to drawdown or accessing with lump sums do have consequences which would need to be considered, although this depends on your personal situation. A good independent financial adviser will be able to work out which combination of options works best for our situation, maximising income and avoiding and potential costly mistakes.
There are several different types of annuity:
Please note that the above are very simple summaries and are provided to show the range of annuity types that exist.
There are different version of annuity’s that determine by how much your annuity payments will increase over time.
As with many decisions around Annuity choices, which are the most suitable depends on your personal situation. Your health, your wider retirement plans, and whether you want to lave an income to your spouse after death are some of the factors to consider. A Pension Adviser will be able to discuss with you in more detail and help select the most appropriate type of annuity.
Unfortunately there is no simple answer to this question. Either by your own research or working with your adviser, you should be able to gain an understanding of annuities and what each type can do for you. However, an annuity is just one part of a retirement strategy and when choosing what type of annuity to purchase (or if at all), then it is essential to look at it alongside the rest of your plan.
There are many things that can be done with retirement planning these days to help maximise your pension income, and the solution will likely involve a mix of different financial products, such as Pensions, Annuities, and others. While Annuities provide a clear benefit (guaranteed income) this does come at a price and it’s important to know if there is another, cheaper, way of achieving the same outcome.
It is key to know exactly what you need out of an annuity, as you are paying for the different features and benefits of each type. As annuities are almost impossible to change once taken out it is important that you make your decision carefully and make sure you examine all the other options and fully understand what benefits you are paying for and if they are value for money for yourself.
Broadly speaking the main difference between a Pension and an Annuity is that a pension is a “pot” into which you save into during your lifetime whereas an Annuity is something you buy after you retire to provide you with a guaranteed regular income.
Pensions are often thought as something you receive after you retire, but this is not technically true. The pension is the “fund” that you build up during your working life and is either a Defined Benefit Pension or a Defined Contribution Pension. A Defined Benefit pension pays out a guaranteed regular income for life after you retire (and so appears similar to an annuity). If you have a Defined Contribution pension then you need to decide how to turn your pension pot into a retirement income, with there being many options available, one of which is to purchase an annuity.
These pension arrangements are all separate from the State Pension, which you can receive from State Pension Age and is mainly based on your lifetime National Insurance contributions. A private pension can be seen as a way to supplement your state pension, to help achieve the post retirement lifestyle you want. More information on the UK state pension can be found here – Understanding the UK State Pension.
If you die, your annuity payment will usually end and the funds you used to buy your annuity are effectively gone. However there are a number of options that you can take to ensure a surviving beneficiary can still benefit from your annuity:
Hopefully this article has helped give a good background in annuities and what they can do for you. It’s important to note that the above article is meant for educational background information only and should not be relied upon to make any financial decisions. Annuities should be considered as part of wider financial planning and, as it is virtually impossible to cancel once taken out, you need to be sure you’re making the right decisions.
If you are considering securing a lifetime income via an annuity then we can certainly offer advice and recommend exactly which option or combination of options would provide for maximum benefits. We can also help if you are earlier on in the process of thinking about retirement and want to build the foundations for a good retirement with an effect plan, ensuring that you are putting enough away today and that it will grow enough to give you the lifestyle you want. This can be part of a wider Financial Plan or standalone Pension advice.