What is an annuity?

See how you could improve your income, which depends on lifestyle, age, health and even postcode! Many people miss out on enhanced annuities simply because they do not know what to ask for. According to a consumer survey from MGM, greater than 70% nearing retirement are simply missing out. See our section on enhanced annuities below.

A pension annuity converts your pension fund into a regular income from age 55. Annuity payments can either be regular monthly payments or larger sums paid less often. You do not actually have to retire.

There are 2 main types of annuity in the UK – a Compulsory Purchase Annuity, purchased from a pension scheme and taxed as earned income or a Purchased Life Annuity that is purchased from other capital and therefore possibly taxed at a lower rate.

Annuity rates

Annuity rates differ for men and women of the same age due to life expectancy. Annuity rates for women are generally lower than for men as they are expected to live longer. All things being equal, annuity rates increase the later you start due to decreased life expectancy.

Fixed & variable annuities

A fixed annuity guarantees your payments, but lower risk generally means lower returns than a variable annuity. A variable annuity allows you to choose where to invest your money. The value of your pension depends on the performance of your investment. It’s imperative that you receive professional advice regarding complex variable annuities.

Enhanced and Impaired-life annuities

If your health is poor, the secret to unlocking extra cash is to purchase either an enhanced or impaired-life annuity. These are not available from all providers.

An impaired-life annuity pays out more to individuals with specific health problems and reviews particular circumstances in-depth.

An enhanced annuity is more generic than an impaired-life annuity and pays a higher annuity rate to people with particular lifestyles, such as smokers and the obese. Even if you are not eligible for an enhanced annuity, it’s still worthwhile seeing if you can get a better deal – it pays to shop around and be fully informed.

Pension release

Pension release is a term used to describe gaining access to a tax-free cash lump sum from a pension arrangement that is not already in payment. If you choose not to benefit from the full 25% available you will not be able to drawdown the balance at a later date. However, releasing money early may reduce your pension income in retirement, which is why all decisions require careful planning and you should always seek independent financial advice from a specialist.

Once you have released your tax-free amount the balance of your pension fund can only be used to provide an income. This can either be taken straight away or you can defer, leaving the fund to grow in a tax efficient manner until you choose to withdraw an income.

Later, at a time of your choosing, you can then either withdraw a different amount of income each year to suit your income requirements or surrender the entire remaining fund up to an annuity provider to buy a fixed and guaranteed income for life.

Pension release is only suitable for a limited number of people and circumstances and should not be seen as an easy option for raising money.

Income drawdown

Choosing income drawdown allows you to draw a variable income directly from your pension whenever you wish whilst the funds remain invested for potential further growth.

Anyone from age 55 to 75 is eligible for income drawdown. You can designate how much of your pension you want to move into income drawdown. You can then usually take up to 25% of this amount as a tax-free lump sum, leaving the remainder invested from which to draw a taxable income.

Instead of handing your pension to an insurance company in return for the secure income of an annuity, income drawdown is a more flexible alternative where you keep full control and choose where your funds are invested often with the assistance of an IFA or Fund Manager.

With drawdown your income will depend on the performance of your investments, therefore many people choose an annuity to cover their essential living costs and leave the remainder in income drawdown to benefit from the additional flexibility.

Income drawdown allows you to choose the income level you wish to withdraw from your pension up to a capped maximum income set by the Government. However, there is no set minimum, which means you can defer taking an income until you choose to do so. Providing the fund is not eroded by excessive income withdrawals, or poor investment performance, it may be possible to increase your income later on.