Annuities: Turning your pension into an income

How does an annuity work?

annuity is how your pension is made to work properly for you. It’s a type of insurance policy, exchanging the lump sum of your pension savings for a regular income which you can draw regularly for the rest of your life.

How do I buy an annuity?

Check on what pre-retirement savings arrangement you have:

  • Personal pension
  • Stakeholder pension
  • Money-purchase employer scheme

You can use any of these types of fund to buy an annuity.

Do annuity rates change? If so, why?

Yes, annuity rates are not constant. When you exchange your pension pot for a regular income, a number of factors come into play to determine how much you’ll regularly be able to draw:

Your pension savings

The size of your pension savings ahead of retirement will make all the difference to the annuity income offered to you. The bigger the pension pot the higher the annuity income offered.

Your home location

You may receive a higher income based on your postcode if the annuity provider’s life expectancy figures for your area are lower than the average life expectancy age as they would be paying out over a shorter period of time. Such ‘postcode lottery’ decisions are often based on mortality figures in different regions of Britain.

Your state of health

As above. Annuity suppliers could boost your rate if your health is poor and your life expectancy is lower. You do not have to be seriously ill to qualify for a higher annuity rate based on health. Common medical conditions such as high blood pressure and/or high cholesterol are conditions that are considered and it is estimated that 70% of the UK population would qualify for a higher pension income if health details were factored in.

Different rates from different providers

Always shop around on the open market to find the best annuity rates. There’s huge competition and plenty of providers, so rates vary accordingly.

Would an annuity suit me?

An annuity is only relevant if you belong to a defined contribution pension scheme (personal pensions, employer group schemes, stakeholder pensions). But if you’re on an employer’s final salary scheme, this is likely to pay out your pension directly. In this case, an annuity’s not for you.

Your pension provider will ‘nudge’ you to buy an annuity from around 5 years ahead of your retirement, with a reminder 4 to 6 months before the actual date. And you’ll receive an info pack 6 to 10 weeks after you retire if you’ve shown any interest.

In some employers’ money-purchase pension schemes, an annuity could be bought on your behalf by pension trustees. Check with your employer or with an administrator to confirm this.

What drives annuity rates?

well as your own situation, annuity rates depend on a number of external factors:

  • Prevailing value of government bonds (gilts) purchased by insurers to finance annuities
  • The Bank of England base rate: this decides how much interest is paid on gilts by the government
  • Gilts demand: high demand means lower interest payments and in turn lower annuity rates; low demand could mean higher rates
  • Quantitative easing (QE) pushes down gilt yields, since the Bank of England’s mass-purchase of gilts has reduced interest payments

Annuities: for or against?

The pros

  • Regular fixed payment from day 1 of your retirement for the rest of your life
  • Minimal risk (except with investment-linked annuities)
  • Annuities can be linked to inflation to increase annually in value
  • Up to 65% higher income than standard annuities if your health is poor; lower life expectancy means providers pay out over a shorter period

The cons

  • 1-time transaction that can’t be cancelled or withdrawn – so be sure you’re making the right decision
  • Shop around using the open market option (OMO), and think about buying from someone other than your pension provider; with OMO you’ll enjoy more income options and possibly higher rates – often by up to 20%

Get in touch

Don’t delay, contact us today on 0345 357 9000 or email us or simply complete our online enquiry form and we will get in touch with you to discuss your financial advice needs.