What is an Annuity?

If you have been meticulously contributing towards a ‘defined contribution pension scheme’ all your working life, then you should have accumulated a sizeable pension pot by the time you hit 55.

The big question though is what you should do with it.

With the new Pension Freedom reforms introduced in April 2015, you can now take the entire pension pot as one or more cash lump sums receiving 25% tax benefit on each withdrawal.

The other option is to buy an Annuity.

Annuities explained 

An annuity is a product that will give you with a guaranteed retirement income for the rest of your life, in exchange for a part or whole of your retirement pot. It is like life insurance in reverse and is sold by insurance companies.

Most people take 25% of their retirement pot as a tax-free lump sum amount and use the rest to buy an annuity. However, you may also use your entire pension pot to buy one.

Annuity rates may differ from one insurance company to the other and you can either buy one from your current pension provider or shop around for the best rates.

There are many types of annuities. But the two basic types are:

  1. Lifetime Annuity: A lifetime annuity is beneficial if you have a dependent to provide for after your death. It provides you with an income while you are alive and then will pay a nominated beneficiary to be given a fixed income for the rest of their lifetime. If you nominate a dependent child, then the income will only be paid for a fixed number of years.
  2. Fixed Term Annuity: A fixed term annuity provides you with an income for a specific term period (five or ten years). You will then be paid a lump sum amount as ‘Maturity Amount’, which you can either take as cash or use to buy another retirement income product.

How much income will you get?  

Most people have this question in mind while looking to buy an annuity.

There are online Annuity Income Calculators which can give you a ballpark figure.

But the actual income that you will receive will depend on multiple factors.

Some of them are:

  • Your age when you buy the annuity
  • The amount that you have accumulated in the pension pot
  • Your health
  • Your lifestyle habits
  • Annuity rates at the time of purchase
  • The type of annuity you choose
  • The features you choose in the annuity

A large number of people in the UK do not fully explore all possible options before choosing an annuity. Hence, they end up with potentially lesser retirement income than they should receive.

Also, buy an annuity is an irreversible decision. (This will change in 2016)

Hence, it is extremely important that you shop around to find the best annuity rates and features that are suited to your current financial situation and future requirements.

Shopping for your Annuity

Your goal should be to find an annuity that provides you with the maximum income from your pension pot.

  1. Decide on the type of annuity that you wish to buy. Is it a lifetime annuity or a fixed term one?
  2. If you have any health conditions or lead an unhealthy lifestyle, then do not hide it from your pension provider since you may qualify for a higher income by opting for an enhanced annuity. This is also called an ‘Impaired Life’ annuity by some providers.
  3. Speak to your existing pension provider about an annuity and check the rate they offer. Are they offering a GAR (Guaranteed Annuity Rate)? These are extremely valuable as they provide much better rates than the ones generally available. This retirement income can be used as a point-of-reference to shop around for better deals.
  4. Compare multiple annuities for the best rates. Do check if there are any restrictions that apply.
  5. You can hire the services of an annuity broker. While a broker can give you a clear picture of the various options you have, they will not recommend any particular product.
  6. Consult a retirement expert or financial advisor to discuss your findings from the above steps. They will give you the best impartial advice after taking into account your personal and financial circumstances.

Remember, buying an annuity is a one-time decision that will impact your retirement income for life. Ensure that you seek professional advice before making a choice.


If you are looking for a professional financial advisor, read our article, ‘How to Select a Financial Advisor’ for more information.