What is an Annuity?
An annuity is a regular sum usually paid in exchange for the immediate payment of a lump sum. They are a common way of purchasing a pension with a lump sum but can also be used to buy an income with a one off capital payment.
The lump sum is generally foregone immediately but the payments are made regularly until the death of the annuitant. Thus it is a form of longevity insurance, the longer the regular payments are made the more you get in total but if you die early you get far less.
As the risk is taken by the provider the products are usually offered by insurance companies and large financial organisations. The annuity received is in part repayment of the capital plus income on the balance although a composite deal is agreed at the inception as a combined sum.
Your pension funds can be converted into a pension income, paid for the rest of your life, by an annuity.
Personal pensions, Stakeholder pensions, most AVC’s, Occupational money purchase schemes, Retirement annuity contracts and Section 32 policies are types of pension fund that are converted in to lifetime annuities.
Because you or your employer received tax relief as the contributions to the funds received tax relief your annuity income is usually taxable. If the lump sum for some reason did not get tax relief eg a legacy then the capital return element may escape tax.
What Types of Annuity Can You chose?
Fixed annuities are annuities that make payments in fixed amounts or in amounts that increase by a percentage such as RPI.
Guaranteed annuities make annuity payments for at least a certain number of years. The tradeoff between the pure life annuity and the life-with-period-certain annuity is that in exchange for the reduced risk of loss, the annuity payments for the latter will be smaller.
Joint life and joint-survivor annuities, where payments stop upon the death of one or both of the annuitants respectively. For example payments to a married couple can be planned to cease on the death of the second spouse. In joint-survivor annuities, sometimes the annuity reduces the payments to the second annuitant after death of the first.
Impaired life annuities offer improved terms due to a medical diagnosis which is severe enough to reduce life expectancy.
Choosing Best Life Annuity
This may be the biggest purchase or financial transaction of your life so take advice and shop around. You do not need to stay with the pension provider you saved with.
Always check what your provider is offering first and use this as a base to shop around.