Understanding Lifetime Annuities

After years of appearing on the horizon, when retirement finally looms large, the years ahead appear like a haze.

What will retirement life be like? Where will you live?

Can you maintain the standard of living that you are so used to or will there be a drop in lifestyle?

Finally, it all comes down to how well you prepared for the twilight years.

You worked diligently to accumulate every penny that you could and built a small pot that you hope will suffice for the rest of your life.

But with inflation biting away at your savings and increased life expectancy, will your pension pot last as long as you do?

Outliving your pension fund can be a nightmare for most retirees and a lifetime annuity may be the best choice in such a scenario.

What is a lifetime annuity?

In a nutshell, it is a contract between you and an annuity provider (an insurance company) who guarantees to pay you an income for the rest of your life in exchange for a part or whole of your pension pot.

You can choose to draw up to 25% of your pension amount as a cash-free lump sum and use the remainder to buy a lifetime annuity. Alternatively, you can invest the entire pension pot in exchange for your lifetime annuity depending on your individual financial circumstances.

The rule of thumb is that the more you invest to buy an annuity, the more you will be paid every month.

There are two different types of lifetime annuities that you can select and the type you choose, along with the customizations you make, will determine your income for the rest of your life.

Basic Lifetime Annuity 

A Basic Lifetime Annuity offers a bundle of income options that you can select depending on your individual circumstances.

  • Single Life Annuity: If you have no financial dependents or if your spouse or partner has their own pension scheme to rely on, then a single life annuity should be your first choice. In this type of arrangement, you will receive a fixed income for the rest of your lifetime. The payments will stop after your death.
  • Joint Life Annuity: A joint-life annuity is ideal if you have a dependent spouse or partner who does not have a pension scheme of their own. It can also be beneficial if you have dependent children. In this type of annuity, you will receive a fixed monthly income (usually lower than a single life annuity) for the rest of your lifetime. It will then be transferred to your spouse, partner or any nominated beneficiary. In case you nominate your children, it will be paid to them until they reach the age of 23.
  • Fixed Income Annuity: A fixed income annuity will provide you with a fixed monthly income which you and the annuity provider can select beforehand. However, it will not be protected from inflation and if the prices of commodities like food increase over the years, you will be able to buy lesser with the same amount. The advantage of a fixed income annuity is that it starts off with a higher monthly income as compared to an escalating annuity.
  • Escalating Annuity: If you wish to protect your monthly income from inflation, then you can choose an escalating or increasing income annuity. There are two different options that you can choose from.
  1. A preset rate at which your income will rise every year (3 to 4%)
  2. An index-linked option in which your income will be adjusted as per the inflation. If inflation reduces and prices fall, then your income will also subsequently reduce. Alternatively, if inflation rises, then your income will also increase. This protects your monthly retirement income from inflation.
  • Guarantee Period: A monthly fixed income would be paid for a fixed term period (example 10 years) irrespective of whether the annuitant is alive or dead.

Investment-Linked Annuities

Investment-linked annuities are an apt choice if you have other fixed monthly income investments and are willing to take the risk in exchange for a higher monthly payout.

It is directly linked to the performance of your investments. If the investments perform poorly, your monthly income will reduce but not go below a minimum guaranteed amount.

On the other hand, if the investments perform well, the monthly income will increase considerably as compared to a fixed lifetime annuity.

Which should I choose?

Your choice of an annuity should be dependent on your assumptions about future cash flow, your current financial circumstances, your health, dependants if any and your attitude towards risk.