Is an Annuity Right for You?

Key Takeaways:

  • Annuities are one option for retirees to take pension benefits during retirement
  • Annuities provide a guarantee of income, but there may be drawbacks

The options for taking pension benefits have changed in recent years. Taking out an annuity with your defined contribution pension pot was once compulsory, but nowadays it is just one option. We have detailed some of the basics on annuities in the UK here along with some considerations to help you decide if they are are the best way to meet your retirement needs.

What Annuities Are and How they Work

An annuity is a product that provides guaranteed income and can be purchased with all or some of a pension pot. You can typically buy an annuity from your current pension provider, or you can purchase one from a different insurance company.

There are many different types available. The most common are various types of lifetime annuities, which guarantee income for every year as long as you live. Other annuities can be for a set number of years only. These can be useful if you need more money early on in your retirement, and may pay more than you would expect for a lifetime annuity.

Here are some details on some of the different type of annuities—you can check out the UK Government’s Pension Wise website to learn more.[i]

  • Single life: Paid to only one person, normally for their entire life.
  • Joint life: Paid to one person for their life, but after that individual dies, the benefit transfers to another beneficiary, often a spouse or partner.
  • Fixed term: Pays a regular income for a specific number of years, as well as a lump sum payment at the end of the term.
  • Guaranteed period: Pays a benefit out for a set number of years, even if the individual dies within that term. A spouse or partner can then receive the annuity income for the remainder of the period.
  • Enhanced or impaired: May provide a larger benefit if you meet certain life-shortening criteria, such as smoking, or have a medical condition that shortens life expectancy.
  • Escalating: Pays an increasing amount of income each year that may help counteract the effects of inflation.
  • Level: Pays a flat amount of income each year and is not adjusted for inflation.
  • Investment linked: These may have some guaranteed income and some income that is tied to investment performance. The payment amount can vary, and depends on how the selected investments perform.
  • Capital or value-protected: If you die within a certain period and have received less pension income in total than the amount that you originally paid, your remaining policy benefit is paid to your beneficiary.

How Annuity Rates Are Set

When you take out an annuity, the provider takes part or all of your pension pot and agrees to pay you a certain amount each year. This is known as the annuity rate. The figure depends on several factors. Some are financial and others are related to how long the insurance company expects to pay the annuity.

These factors include:

  • The type of annuity you choose.
  • How much is in your pension pot when you take out the annuity.
  • What interest rates are when you take out the annuity.
  • Your age and sometimes, the state of your current health.
  • Where you live—as people in some postcodes tend to live longer than those in other postcodes.

With so many factors involved, annuity rates offered can vary a lot. If you decide an annuity is right for you, it is worth shopping around—and talking to an adviser could help you make the right decision.

Annuities and UK Tax

Depending on your circumstances, you may be able take up to a quarter (25%) of what is in your pension pot as a tax-free lump sum.* The tax-free amount doesn’t use up any of your Personal Allowance. You will only start paying tax when your income for the year exceeds that amount.

You can use all or part of the remaining portion of your pension pot in a variety of ways. If you choose an annuity, the income you receive from it is taxed like normal income. The exact figure will depend on your tax rate and your total income, taking into account any other money coming in.

Pensions and Annuities

Normally, individuals with defined-contribution pension schemes need to decide how to take their pension benefits—purchasing an annuity, keeping funds invested for income drawdown, or withdrawing as cash. If you have a defined-benefit pension scheme, you will already receive a guaranteed, secure income for life, with the amount increasing each year. A defined-benefit pension scheme pays an amount based on a number of factors, including the numbers of years you have worked for your employer and the salary you earned.

It is possible to take some of a defined-benefit pension as cash, or potentially transfer the scheme to a defined-contribution plan.[ii] However, there can be drawbacks to transferring out of a defined-benefit plan, no matter what option you are considering transferring into. That is why if the value of your defined-benefit pension is over £30,000, you are required to take advice from a regulated financial adviser before making a transfer.[iii]

What Potential Drawbacks do Annuities have?

If you are considering an annuity, you should be aware of some of the potential drawbacks. Here are some details on potential disadvantages:

  • Lack of Growth: Some annuities provide a fixed benefit. If inflation rises, and your annuity benefit doesn’t adjust for inflation, its purchasing power will decrease over time. Plus, if you buy when the annuity rate is low, your income is fixed at that rate and you won’t benefit if rates rise in the future.
  • Inflexibility: Will you need more or less income later in retirement? If your annuity does not allow for flexible withdrawals, you will not be able to adjust what you receive—even if your situation changes. Additionally, once you have purchased an annuity, after a short period—usually 30 days—you are usually unable to leave the contract or change it.
  • Lack of Control: Once you have purchased an annuity, you are generally locked into your decision. You have to decide what income type you want and any additional benefits at the outset.
  • Funding others: Do you need to provide financial support to a spouse or dependents? Do you want to leave money from your pension to individuals or a charity? Some annuity payments stop when the annuity holder dies, and others may have a reduced benefit if they also provide a benefit after the purchaser’s death.
  • Cost: Annuities charge fees, and some annuities with additional benefits or complexity, like some investment-linked annuities, may charge fees that could reduce your monthly benefit.[iv]

How Fisher Investments UK Can Help

You have a number of important decisions when it comes to pension pots and your retirement income. An annuity may not be the best decision for you, and it is far from your only choice. If you do choose an annuity, the variety of annuities to choose from can feel daunting.

Fisher Investments UK may be able to assist you with your retirement income planning. We have helped investors in the UK learn more about their investment choices, and to figure out the best fit for their retirement needs.

Contact us today to learn more, or download one of our educational guides as the first of our ongoing insights to learn more about your investment options.

*This webpage should not be construed as tax advice. Please contact your tax professional if you have any questions.

[i] Source: UK Government Pension Wise website, as of 30/04/2019.

[ii] Source: The Money Advice Service, as of 30/04/2019.

[iii] Source: The Pensions Advisory Service, as of 30/04/2019.

[iv] Source: The Money Advice Service, as of 30/04/2019.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.