An annuity is a regular income paid in exchange for a lump sum, usually the result of years of investing in a pension scheme.
Most people will buy one with their pension pot in retirement. It is the usual way of converting this into income. There are others, such as ‘drawdown’, but advisers usually recommend that only those with larger incomes go down this route. If you’ve got a largey pension pot to play with, speak to an adviser to find the right option for you.
There are different types of annuity. The majority of annuities are conventional and pay a risk-free income that is a guaranteed for life. The amount you receive will depend on your age, the size of your pension fund and, in some circumstances, the state of your health.
What affects annuity rates?
The amount you get each year is dependent on the annuity rate available when you retire. Evidence suggests that you can boost your pension income by up to a third if you shop around, but , two out of three people don’t shop around for an annuity. Insurers are obliged to tell customers they can buy an annuity from a different provider – known technically as exercising the “open market option” – but many bury this information in the small print when they send out their retirement packs.
If you don’t feel confident shopping around, talk to an annuity adviser. But while some advisers will take a commission, most now charge a fee. This can make advice prohibitively expensive for those with relatively small pension pots.
Tell the truth about your health
An estimated 50% of people could get a higher income in retirement if they mention 3 key points to their annuity provider: are they on any medication, have they ever been admitted to hospital and do they drink or smoke?
Answer yes to any of these and you’ll probably qualify for an enhanced pension income. You don’t have to be at death’s door to get a better rate; even a minor condition that is being managed with medication or diet can make a difference.
Get the right annuity for you
There are different types of annuity. Some will pay a pension to your spouse on death, and others will inflation-proof your income. They are more expensive, though.
- The most risky options here are income drawdown plans, where your money stays invested and you draw down an income.
- A less risky option is with-profits and unitised annuities. These provide a minimum level of income, and, if the underlying investments perform, the income should rise, helping protect your income against inflation. The opposite can also occur, of course.
- It’s possible to buy shorter-term annuities, for between three and 10 years. These pay a guaranteed income during the period – there is no investment risk – and people simply buy another annuity at the end of the term.