Understanding annuities: A simple guide

One important option to consider when planning for your retirement is an annuity. An annuity is a product you can buy with some or all of your pension fund that gives you a guaranteed regular income. This can be for the rest of your life, or for a set number of years, depending on the product. In this guide, we break down some of the different types of annuities available.

Lifetime annuity

What is it?
A lifetime annuity provides a regular income for the rest of your life. You exchange a lump sum from your pension funds for a guaranteed regular income. You can choose how often you receive it - monthly, quarterly, six monthly, or annually. You can also choose whether you want to add other benefits, such as passing it on to a family member or partner after you die.

Pros:

• You receive a guaranteed income for life.
• Your annuity income is not affected by market fluctuations.
• It can provide you with peace of mind knowing your money will never run out.
• You can add certain benefits to increase your income in line with inflation.
• You can add death benefits to pass on some money to your beneficiaries.

Cons:

• Your pension income may not keep up with inflation.
• You can't cancel it or change what you receive once you've bought it.

Compare lifetime annuities with Annuity Ready
Fill in our form to compare lifetime annuities from all online providers. You'll also have the option to request quotes from offline providers so you can compare quotes from all providers in the UK open market.

Joint lifetime annuity

What is it?
This is like a lifetime annuity, but the income continues to be paid to a surviving named spouse, civil partner or financially dependent partner after your death. It usually pays a percentage of the income you originally received to your named beneficiary. This percentage is chosen by you when you purchase your joint lifetime annuity. Joint lifetime annuities are also called joint life annuities or spouse's annuities.

Pros:

• Provides financial support for a named spouse, civil partner or financially dependent partner after your death.
• Continued income security for the surviving spouse, which can be very useful if they don't have their own retirement income.

Cons:

• Initial income is likely to be lower than a single life annuity.

Compare joint lifetime annuities with Annuity Ready
With Annuity Ready, you can compare and edit quotes to see how your rate would be affected by choosing a joint life annuity.

Enhanced annuity

What is it?
An enhanced annuity is a type of lifetime annuity that will provide you with an increased income. You may be eligible for an enhanced annuity if you have been diagnosed with an illness that could reduce your life expectancy. This includes any conditions you’ve had during your lifetime.

Conditions such as asthma, heart attacks, cancer and strokes can affect the rates. Certain lifestyle factors could also mean you get a higher income, such as being overweight and/or smoking regularly. These are also known as impaired life annuities.

Pros:

• You can receive a higher income if you’re diagnosed with certain health conditions.
• You may get higher rates the worse your health is.
• Tailored to individual circumstances.

Cons:

• You may have to provide a doctor's report and, in some cases, undergo a medical examination.
• If your life expectancy is under a certain time period, an annuity may not be possible. Instead, you might be able to access all your pension funds tax-free.

Compare annuities with Annuity Ready to see if you can get an enhanced rate
When getting an online quote with Annuity Ready you will be asked a number of questions about your health and lifestyle. The answers will be used to determine if you are eligible for an enhanced annuity.

Investment-linked annuity

What is it?
This is a type of annuity where part of your income is guaranteed, and part depends on investment performance. You can choose what proportion of your income you want to guarantee, and the rest will be invested. The part that is invested may provide extra income depending on investment returns.

Your invested annuity income can fluctuate. If investment markets are performing well, you will receive higher levels of income. However, if markets are down, you may only get the minimum guaranteed amount.

Pros:

• You may receive a higher income if your investments perform well.
• You can choose to guarantee a proportion of your income, allowing you some control over the level of risk.

Cons:

• Your invested income can fall if stock market performance is down.
• It may not be suitable if you need certainty around how much income you will receive.

Annuity Ready are unable to provide quotes for investment-linked annuities.

Fixed term annuity

What is it?
Like a lifetime annuity, but with payments guaranteed for a fixed period, or until you die, if this is earlier. You can choose a term between one and forty years, but five to ten years is common. When the fixed period ends, you typically get a ‘maturity amount’. This is the money you put into the annuity, plus any increase from investments, but less any money you’ve already received.

These are also known as short-term annuities.

Pros:

• You’ll get a guaranteed income for a specific duration of your choosing up to 40 years.
• You have the flexibility to reassess your financial needs at the end of the term.
• If you die before your fixed term ends, the maturity amount can usually be paid to a nominated beneficiary.
• If the annuity rates increase when your fixed term ends, you might get a better rate with a new annuity as you’ll be older, and your health may have declined.

Cons:

• If annuity rates drop during the term, you may get a lower maturity amount. You may also get a lower rate next time.
• Your pension income may not increase with inflation.
• Your income is not guaranteed for life.

Annuity Ready are unable to provide quotes for fixed term annuities.

Purchased life annuity

What is it?
You use a lump sum to buy a guaranteed income for life or a fixed term. You could buy it with money from savings, from the sale of a house or using the tax-free lump sum you can take when you originally take money from your pension.

When you get a payment from this type of annuity, it’s made up of two parts. One part is the return from the money you originally put in (the capital). The other part is the extra money you earn (the interest). You don’t have to pay income tax on the money you originally put in. You only have to pay tax on the interest.

Pros:

• You’ll get a guaranteed regular income for life or a fixed term.
• You only get taxed on part of your income.
• You have the option to protect your capital, meaning you’ll always get at least as much income before tax as the amount used to buy the annuity.
• You can choose to pass on your income to a loved one if you die.

Cons:

• It is not suitable if you want to withdraw all of your funds in one lump sum.
• Your income may not keep up with inflation.

Annuity Ready are unable to provide quotes for purchased life annuities.

Looking for guidance?
Understanding the different types of annuity is vital for making decisions about your retirement. Consider your needs, financial goals, and preferences when choosing the annuity that best suits you.

If you are aged 50 or over you are entitled to free and impartial guidance from Pension Wise, a government service from MoneyHelper. You can receive tailored guidance online or over the phone to help you understand your retirement options.