Key Things To Consider Before Arranging Your Retirement Annuity


Now you’ve done most of the hard work in your life, it’s time to start thinking about your retirement. You’ll have a few things to consider between now and your last day of work, one of which is how you’ll take your pension. Will you take an ‘income drawdown’ or will you invest in an annuity (or a bit of both)?

As with most things in life, the choices you make are largely dependent on your personal situation and on you as a person. This article will help you to look at your options and go through important points for you to consider along the way.

The first point to address is what an annuity actually is.

What Is An Annuity?

An annuity is basically a special type of insurance policy that you take out close to retirement. Its purpose is to provide you with a monthly income in your retirement years.

Typically, an annuity will provide you with a fixed income every month for the rest of your life. The amount you receive will be dependent on several factors. The factors include:

  • How much you invested in it to begin with
  • Your life expectancy
  • The annuity provider that you choose

All of these points will be addressed in the subsequent sections. One point that’s really important to be aware of is that annuities are generally fixed once they have been taken. So it’s really important that you choose wisely because once you do choose, you’re unlikely to be able to change it.

The difference in how much you will receive from one annuity to the next can be as much as 20%. If it feels a bit daunting right now, it shouldn’t by the time you’ve finished reading.

How Do Annuities Work?

There are several different types of annuities available to you, each providing slightly different benefits and advantages. In very simple terms, the way an annuity works is that you hand over your pension pot to an annuity provider.

Based on several variable factors, the annuity provider will then provide you with a monthly income, often for the rest of you life. Some annuities will only provide an income for a fixed period, depending on which type you choose.

What Types of Annuities Are Available?

There are several types of annuity available to you. Each type has several different options you can select. Depending on your personal circumstances, some annuities will be more appropriate for you than others.

The main differences between annuities available are:

  • Different levels of income provided
  • Whether it will provide income for only you or for you and your dependents
  • The different options that are available with the annuity

Below is a list of the different types of annuities available today:

Lifetime Annuities

  • The most common type of pension annuity
  • Also known as ‘compulsory purchase’ annuity
  • Provides an income stream for the rest of your life (or the rest of the lives of the other persons named on the agreement for the rest of their lives)
  • The annuity rate is the amount of income that you will be offered for each pound of pension fund
  • The rate offered is based on two things:
    • 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

Enhanced Annuities

  • A type of lifetime annuity offered by some providers
  • May offer a higher annuity rate and, therefore, a higher income than a regular lifetime annuity if you meet certain criteria which could shorten your life expectancy, such as:
    • Whether you are or have been a smoker
    • Whether you are overweight
    • Whether you have spent a significant part of your working life in a hazardous environment
  • Additional questions may be asked of you before you are offered an enhanced annuity rate
  • The annuity rate you’re offered is based on the average life expectancy for people that meet the above criteria

Impaired Life Annuities

  • A type of lifetime annuity offered by some providers, designed for people that currently suffer or have previously suffered from a medical condition that results in a reduced life expectancy
  • To qualify for this type of annuity, you will need to complete a questionnaire about your medical history
  • The annuity provider may also ask for further information from your doctor
  • They may also 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

Postcode Annuities

  • A type of lifetime annuity offered by some providers where the annuity rate you are offered is based on where you live
  • The premise being that people in one area of the country have different life expectancies than people from another area
    • For example, people living in a wealthier area are generally considered more likely to live longer than someone living in a poorer part of the country
  • If you’re expected to live for longer, your annuity will need to be paid for longer, which means you are likely to be offered a lower annuity rate than if you are expected to have a lower life expectancy

Temporary Annuities

  • A type of annuity that only pays an income for a fixed term (or until you die, if that is earlier)
  • The maximum term for a temporary annuity is 5 years
  • This type of annuity may be useful if you need income today but don’t want to commit to a lifetime annuity just yet
  • This type of annuity is likely to offer a far higher annuity rate than an equivalent lifetime annuity because the period over which the annuity will be paid is likely to be shorter
  • This means 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)

Investment-linked Annuities

  • A type of lifetime annuity where part of the income is guaranteed and part is linked to the performance of investments
  • You select the guaranteed level of income you want and a portion of your pension fund is used to provide it
  • The remaining balance of your pension fund is then invested
  • Those investments then pay an additional income based on the investment returns received
  • If the investments are performing well, you would receive a higher level of income
  • On the other hand, if the markets are falling, you might only receive the minimum guaranteed amount
  • Investment-linked annuities are basically halfway between:
    • A conventional lifetime annuity, and
    • Drawing your income from the money you’ve built up in your pension fund without the need to buy an annuity

Purchased Life Annuities (PLAs)

  • A type of annuity that is purchased with money that is not in your pension pot, but can be purchased with your pension commencement lump sum (PCLS) once you’ve taken it
  • PLAs can provide income for the rest of your life — and for your surviving dependant
  • Or it can provide a temporary PLA for a fixed number of years — or your death if earlier
  • PLAs have the same options as pension annuities but are treated slightly differently for tax purposes:
    • Part of each income payment is treated as a return of the initial capital invested. As such, it is not subject to income tax
    • The amount of this return of capital depends on your age at the time you purchased the PLA
    • PLAs 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 amount invested as the purchase price

Do I Have To Take Out An Annuity?

No you do not.

An annuity is just one way to provide an income for yourself in retirement. As we mentioned at the very beginning of the article, there are many factors that will need to go into your decision process.

One of those factors in decision making revolves around your personality type. Do you prefer to have guarantees that help you to feel safe and secure, or do you have more of a risk taker trait that yields greater wins (when the risks pay off)?

An annuity can help provide you with a sense of certainty about your future. You can also build in an ongoing continuing income to a surviving dependent in the event of your death.

Mix And Match

You may recall at the beginning of this article we mentioned about taking an ‘income drawdown’ instead of an annuity, or the option to take both.

You do have the option of using a portion of your pension pot to purchase an annuity and then to take the remainder of your pot as a lump sum, tax-free — this is known as a pension commencement lump sum (PCLS).

There are other ways of providing yourself with an income, including just taking the whole lot as a lump sum.

Navigating The Pension Minefield

Understanding financial terminology and the various options with associated sub-benefits can be a minefield for some people. It can be a stressful time of your life transitioning from having worked for the past four or more decades to winding down and enjoying the next period of your life.

Whether you’re feeling stressed and confused or whether you feel quite confident but just need some additional guidance, help is available.

From simple pensions guidance to a full and thorough pension review with a selection of your best options, get in touch and we will assist you.

There are two ways to get started: you can either call us on our free phone number 0800 031 6078, or you can pop your contact details into the short form above and we will call you.

Getting your retirement sorted and under control needn’t be stressful.