An annuity is a financial product that allows you to convert your pension savings into a guaranteed, fixed income for the rest of your life - often referred to as a secure income.
Choosing an annuity is a significant decision, as it is usually irreversible. That’s why it’s essential to fully understand how annuities work, the different types available, and the features they offer before making a commitment.
Understanding Annuities
By using your pension savings to purchase an annuity, you receive a steady income for life. You can choose how frequently you get paid - monthly, quarterly, biannually, or annually.
The income you receive depends on factors such as the size of your pension pot, your age and health at retirement, and any additional features you select.
It’s important to consider whether this income will be sufficient to support your desired lifestyle. While an annuity provides financial stability, factors such as inflation and rising living costs could impact the real value of your income over time.
Purchasing an Annuity
Like other pension withdrawal options, you can buy an annuity from the age of 55 (rising to 57 from 6 April 2028). However, if you have a protected pension age or are in poor health, you may be eligible to buy one earlier.
You don’t need to use all of your pension savings to purchase an annuity. For instance, you can withdraw a lump sum first and then use the remaining amount to secure a regular income.
Types of annuities explained:
Lifetime Annuity
A lifetime annuity guarantees a steady income for life. The amount you receive is based on your pension savings, age, and health status at the time of purchase.
Fixed-Term Annuity
Also known as a certain-term or short-term annuity, this option provides a fixed income for a specific period. You purchase it using part of your pension, while the remaining funds remain invested. When the term ends, you can either take a lump sum or reinvest in another retirement income product.
Enhanced Annuity
An enhanced annuity considers your health and lifestyle, potentially offering a higher income to those with lower life expectancies. You may qualify if you:
Have a long-term illness
Suffer from a serious medical condition
Are a smoker
Are overweight
Joint-Life Annuity
Unlike other annuities that stop payments when the policyholder passes away, a joint-life annuity continues providing income to a nominated beneficiary (such as a spouse or dependent). This is particularly beneficial if your partner has minimal pension savings.
Inflation-Linked Annuity
This type of annuity adjusts payments annually to align with inflation, often tracking the Retail Price Index (RPI). Initially, payments may be lower than those of a standard annuity, but they increase over time to maintain purchasing power.
Investment-Linked & With-Profit Annuities
With these annuities, your income fluctuates depending on investment performance, such as stocks and shares.
Guaranteed Annuity
You can choose to guarantee your annuity payments for a set period (up to 30 years). If you pass away within that time frame, payments may continue or a lump sum be paid to your nominated beneficiary.
Benefits and Features of Annuities
Understanding the benefits and features of an annuity can help you decide if it’s the right option for your retirement plan:
Guaranteed lifelong income – Your pension savings won’t run out, though the amount may fluctuate with investment-linked annuities.
Financial stability – You’ll always know how much to expect in each payment cycle (monthly, quarterly, etc.).
Support for your loved ones – Options like joint-life annuities and guaranteed annuities ensure your dependents continue receiving an income after your passing.
Tax-free lump sum – Typically, you can withdraw up to 25% of your pension tax-free before purchasing an annuity.
Flexible income choices – You can select fixed or increasing income and tailor the frequency of payments to suit your needs.
Higher income for those in poor health – Enhanced annuities offer increased payouts to individuals with specific health conditions or lifestyles.
Important Considerations Before Committing
Before purchasing an annuity, take time to evaluate the following:
Irreversible decision – Once an annuity is purchased, you cannot change your mind or withdraw a lump sum later.
Potentially lower total payouts – Some annuities stop paying once the policyholder dies, meaning you may not receive the full value of your pension.
Tax implications – Your annuity income may be subject to income tax, depending on your financial situation.
No surrender value – Unlike other investment products, annuities cannot be cashed in if your circumstances change.
Accuracy of health details – If you qualify for an enhanced annuity, ensure that you provide accurate health information, as incorrect details could impact your payments.
Annuities provide a secure and predictable income, making them a reliable option for retirement planning.
However, because they are a long-term commitment, seeking professional financial advice is strongly recommended.
While financial advisers may charge a fee for their services, they can help you make the most informed decision for your future.
For a free initial conversation, get in touch to help us explain your options: https://www.charlesjames.com/contact-us