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In this guide, we’ll explain your annuity choices, how they work, and what to consider when tailoring an annuity to suit your needs.
This guide offers useful information, but it is not advice or guidance, and we recommend that you get professional support when choosing an annuity.
What is an annuity?
An annuity is a financial product that turns your pension savings into a guaranteed income for life or a fixed period. You can buy an annuity with some or all of your ‘defined contribution’ pension pot, typically from age 55 (rising to 57 from April 2028).
Once in place, your annuity pays you a regular income regardless of how the investment markets perform – which can provide valuable security in retirement.
What types of annuities can I choose from?
Several types of annuities are available in the UK, each suited to different retirement goals and personal circumstances.
1. Lifetime annuity
This guarantees an income for the rest of your life, no matter how long you live. You ‘lock in’ your income based on your chosen provider’s annuity rate when you take out the annuity. It takes investment risk out of your retirement income – but it does mean that you will not benefit from any future growth in the investment markets. Read more about lifetime annuities
2. Enhanced (or impaired life) annuity
If you have certain health conditions such as diabetes or high blood pressure, or have made certain lifestyle choices such as smoking or drinking, you may qualify for a higher income than standard rates.
This is because your life expectancy may be shorter (on average) and annuity providers therefore anticipate paying income for a shorter period. As a result, they can offer higher regular income payments.
You don’t need to be seriously ill to benefit – even relatively common conditions could qualify. Just be aware that enhanced rates are only offered on lifetime annuities, not fixed-term plans. Read more about enhanced annuities
3. Fixed-term annuity
Rather than locking into a guaranteed income for life, you might prefer a fixed-term annuity. This provides a guaranteed income for a set number of years.
For example, someone aged 62 might want to use a fixed-term annuity to get an income until their State Pension and maybe another private pension kicks in at age 66. The fixed-term annuity could bridge the four-year gap, enabling them to fully or partially retire early.
Fixed-term annuities have a very useful option called the guaranteed maturity amount (GMA). You set this up when taking out the annuity, and it guarantees a known lump sum at the end of the term. That means you get a guaranteed rate of return, as well as guaranteed income.
You can take this lump sum as taxable cash, use it to buy another annuity, set up an income drawdown plan, or invest however you choose. It gives you flexibility if you’re unsure about committing to a lifetime annuity. Read more about fixed-term annuities
Now that we’ve summed up the three types of annuity, let’s move on to some features and options to consider…
Should I choose a level or escalating income?
Annuity income can be tailored based on whether you want payments to stay the same or increase over time:
Level income: With this option, your payments remain fixed, giving you consistent income each month or year. While this offers a higher starting income than an increasing income, inflation will gradually erode your purchasing power.
Escalating income: Here, your income rises annually – either by a fixed percentage (e.g. 3% or 5%) or in line with inflation measures like the Retail Prices Index (RPI). While you’ll start with a lower income, it helps preserve your spending power as prices rise.
We’d suggest getting some annuity quotes for both level and increasing annuities, so you can see what your particular income would look like with each option.
What happens to my annuity when I die?
Many people worry that buying an annuity means losing their pension savings if they die early in retirement. Fortunately, options are available to protect your income for loved ones:
Joint life annuity: Your annuity continues to pay a percentage of your income to a partner or other beneficiary after your death. You can usually choose how much of the income they’ll receive.
Guarantee period: This option ensures your annuity pays out for a minimum number of years, even if you die during that time. If you pass away early, payments continue to your estate or a named beneficiary for the remainder of the term.
Value protection: This feature ensures that if you die before receiving the full value of your original pension pot, the balance is returned to your beneficiaries as a lump sum.
Choosing any of these death benefit features will likely reduce your own annuity income. The trade-off is knowing that your annuity might provide a lump sum or income for someone you care about after you are gone.
As with the level/escalating option, we’d suggest getting annuity quotes comparing these death benefit options. Also, our selected annuity partners will be happy to talk through these options in more detail, answering any questions you may have.
Other annuity features to consider
When buying an annuity, other choices can influence your income and flexibility:
Tax-free lump sum: Most people can take up to 25% of their pension pot as a tax-free lump sum before buying an annuity. This reduces the amount used to generate income but provides valuable tax-free cash up front. Think carefully about how much lump sum you need – taking less may mean a higher income from your annuity.
Payment frequency: You can choose how often you receive your annuity income – monthly, quarterly, half-yearly or annually. Some providers also let you pick whether payments are made in advance (at the start of the period) or in arrears (at the end). Your choice may change slightly the size of your regular income payments.
Can I change my annuity later?
In most cases, annuities are permanent once purchased and you are not able to change them. That’s why it’s crucial to fully understand your options so you can make the right decisions at the outset.
Why it’s essential to shop around
One of the most important things you can do is compare annuity quotes from different providers. Annuity rates (and therefore income) can vary significantly across providers. You have a legal right to use the open market option, which means you don’t have to buy an annuity from the company currently holding your pension fund. By exploring your choices, you could boost your income significantly.
Make sure to speak with a specialist who can help you compare quotes and explore all your options – it could make a significant difference to your retirement income.