What is an Annuity Pension?

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What is an Annuity?

Buying an annuity is a way of turning a pension pot into an income for life. At retirement you exchange your accumulated pension for a regular income from an annuity company.

Most people are familiar with annuities. Until 2015, they were the only option for the vast majority of retirees with a defined contribution / money purchase pension.

The introduction of the pension freedoms in April 2015 changed this, opening up the more flexible option of pension drawdown to anyone who wished to use it.

However, you can still buy an annuity pension if you want to secure yourself a guaranteed retirement income for the rest of your life. This guide explains annuities, defining what a life annuity is and how they work. It also offers a chance to compare annuity rates from the UK’s leading providers.

How Do Annuities Work?

When you buy an annuity, you take the amount you’ve accumulated in your pension pot throughout your career and exchange it for a regular income for the rest of your life. You can choose to have your income paid monthly, quarterly, biannually or annually.

Annuities essentially work like Life Insurance but in reverse. Rather than paying regular premiums and receiving a lump sum on your death, with annuities you pay a lump sum at retirement and receive regular returns for life.

You don’t have to use your entire pension pot to buy an annuity. You can use part of your retirement savings to do so and access the rest of your pension under the new pension freedom legislation if you want.

There’s also no need to buy an annuity on the exact day you retire if you don’t want to.  Annuities are available to purchase as and when you see fit (or not at all).

Under the old rules, you had to buy an annuity at age 75, no matter how you started taking your pension income. Thanks to the pension freedoms this is no longer the case.

If you die early during the annuity, you may not live long enough to see all of your capital return.

Conversely, though, you may live a long time after purchasing your annuity. If so, you may end up receiving see more back from the annuity company than you paid in.

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Types of Annuity

There are many different types of annuity available. You can also adjust and add to the various types on the market in a way that will impact how much your annuity is worth and how it is paid.

Single vs Joint Annuities

The simplest annuities are single life annuities, where the annuity is just based on the life on one person, known as the annuitant. Annuitant is just the technical term for someone receiving an annuity.

A single annuity pays out an income to one person, usually for the rest of your life (but potentially for a fixed period depending on the type of annuity you buy).

joint annuity pays you an income for life but then, on your death, transfers to a selected beneficiary until their death. This could be a spouse, partner or any other chosen beneficiary, who’ll receive the income until they pass away. Alternatively, you could pass your annuity to a dependent child and the annuity will usually pay out until they’re 23.

John Spink Head of Financial Planning at Drewberry

A joint annuity can be a better option than a single annuity if you have a spouse or partner with little to no pension arrangements of their own.

The income your partner will continue to receive after your death is usually expressed as a percentage of your retirement benefit, e.g. 50% or 100%.

John Spink
Head of Financial Planning at Drewberry

You decide on how much your partner will continue to receive when you take out the annuity, but the more you want to offer them in income after you pass away the lower your initial annuity pension will be.

Enhanced Annuities and Impaired Life Annuities

Unfortunately, not everyone makes it to retirement in good health. Some people even have to retire early due to illness. If you’re unwell at retirement, though, it could work in your favour in the form of a larger pension from an enhanced annuity.

Enhanced annuities are offered to people with lower than average life expectancies, which is why they’re sometimes known as impaired life annuities. They can increase your pension income by up to 50%.

Annuities for smokers are usually enhanced annuities because smoking reduces life expectancy. However, most impaired life annuities are given to people with life-limiting medical conditions, such as:

  • Cancer
  • Diabetes
  • Heart disease
  • High blood pressure
  • Kidney failure.

Depending on the severity of the condition, other medical problems may also qualify, such as asthma, high cholesterol and obesity.

Joint Enhanced Annuities

You may be able to get a joint annuity on enhanced terms if your partner depends on your financially, even if you’re perfectly healthy and it’s your partner who’s ill.

Similarly, if you’re ill and your partner is healthy you’re likely to get an enhanced joint annuity rate — although perhaps not enhanced to the degree it would be if it was a single enhanced annuity or if you were both ill.

What are Immediate Needs Annuities?

An immediate needs annuity is an annuity that you use to pay care home fees. They’re also know as immediate care plans and immediate need care fee payment plans. They’re designed to cover any gap between your income and the cost of long-term care.

The benefit of an immediate needs annuity is that it’s tax-free because you technically never receive the money — it all goes to the retirement home to pay for your care.

Immediate needs annuity costs will be determined by the usual factors, such as your age, state of health, the size of the lump sum you’re using to purchase the annuity and your life expectancy.

You can ensure that your annuity income will rise in line with future increases in care home fees by building this into your plan. This way, you can be sure that you never run out of money to pay for long-term care, no matter how long you live.

What are Short-Term Annuities?

Short-term annuities are as simple as they sound. Rather than lasting for the rest of your life, as is usual for annuities, payments will only continue for a set period, e.g. 5-10 years, or until you die (whichever occurs first). For this reason short-term annuities are also known as temporary annuities.

The benefits of a short-term annuity are that, because you’re only securing income for a short period, they don’t cost as much as a ‘normal’ long-term annuity that pays until your death. This may therefore leave spare funds not tied up with an annuity for you to invest and draw an income from.

Not committing everything to a life annuity today may mean that, should annuity rates rise in the future, you may benefit from purchasing an annuity at a later date. Also, as you age, your annuity rate will rise anyway if you look to purchase a long-term annuity in the future.

Should I Get a Level or Escalating Annuity?

A level annuity will never rise beyond what was agreed when you first bought an annuity. So if you bought an annuity aged 60 that pays you £10,000 a year and survive to 90, you’d still be receiving £10,000 every year.

Although your benefit hasn’t dropped, in ‘real’ terms (i.e. inflation-adjusted terms), it won’t be buying you the same basket of goods at the end of that 30 year period.

In 2016 the average price of a pint of milk was 42.7 pence — up from 23.9 pence in 1986!1 You can see how a fixed benefit today could easily be eaten up over 30 years by inflation.

An escalating annuity, also known as index-linked annuity or an indexed annuity, will rise over time. You can either have your annuity rise each year by a set amount — say 3% — or it can simply be tied to inflation and maintain pace with that.

While this reduces the risk of your benefit being eroded by inflation, it will be at the cost of a smaller annuity at the start to reflect that you’ll be receiving a higher income over time.

1 https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/cznt/mm23

What Are Fixed-Term Annuities?

Provides a set income for a fixed period (typically between 5 and 10 years), but then unlike a short-term annuity it pays a ‘maturity amount’ at the end of the period. This maturity amount can be used to invest in another retirement product, perhaps a long-term annuity, another fixed-term annuity or however else you see fit.

You can adjust the annuity, although the higher the income you need the lower the maturity amount will be. The main benefit of a fixed-term annuity is that you don’t have to lock in a product for life and when the term ends you can find another retirement product if required.

The risk with fixed-term annuities is that you don’t have control over the maturity amount. Market conditions may mean that the amount you receive at the end isn’t enough to continue to provide the retirement income you need.

What is a Deferred Annuity?

A deferred life annuity is one that you buy but then don’t start receiving an income from until a later date. The longer your deferred period, the better the annuity rate.

What is a Value-Protected Annuity?

Also known as capital protected annuities, these are one way in which you can secure a return of unspent capital in your pension pot when you pass away. No other life annuity will return ‘unused’ pension cash in this way.

The lump sum you receive back is equivalent to the amount you paid for the annuity minus the gross income (pre-tax) you’ve received from it.

If you die before the age of 75, your beneficiaries can receive this value protection payout from your life annuity tax-free. If you die after the age of 75, the amount your beneficiaries will get will be added to their income and taxed as income in the usual way.

When you add capital protection to an annuity, you’ll be sacrificing income to make up for the fact that you’ll be receiving a returned lump sum. Shop around to find the best deal and ask a pensions adviser whether this is the best thing. Alternatives include other annuity protections, such as a guarantee period.

Are Investment-Linked Annuities a Good Idea?

Investment-linked annuities are generally seen as a riskier alternative to a traditional annuity. With an annuity, you’re guaranteed an income for life (or a fixed period, depending on the type of annuity you choose). This income will be yours regardless of how the money you invested with the annuity company is performing.

With an investment-linked annuity, however, your income will depend on the performance of the underlying investment, which may include stocks and shares.

This is good news if the stock market rises because you’ll benefit from a higher income than if you’d stuck with a traditional life annuity.

However, if the stock market falls your income will also likely fall. (This said, most investment-linked annuities offer a minimum income guarantee.)

There are two types of investment-linked annuities: with-profits annuities, where your income is linked to the annuity company’s with-profits fund, and unit-linked annuities, where you get to choose your investments.

As your funds will be managed in an investment environment, you’ll usually need to pay ongoing fund management fees for an investment-linked annuity. This would not be the case for a traditional life annuity and will eat into your retirement income.

What Are Purchased Life Annuities?

Pension annuities can only be bought with a pension pot, something that applies to most annuities. Purchased life annuities are purchased with other monies you may have (although potentially you could use your pension commencement lump sum). This could include the sale of a property or an inheritance.

A lifetime purchased life annuity can still provide you with a guaranteed income for the rest of your life and they have all the same options as pension annuities — however, they’re treated very differently for tax purposes which may be to your benefit.

Unlike pension annuities, which assume you’ve received tax relief on the money used to purchase them and so are taxed as income, purchased life annuities work differently. Part of each payment is treated as a return of the initial capital invested and is therefore free from income tax.

The proportion of your payment made up of return of capital will depend on your age when you purchased the annuity. With a purchased life annuity, tax is only paid on the interest your investment earns.

Should I Buy an Annuity?

Reasons for an Annuity

 Reasons Against an Annuity

Guaranteed, lifelong income

Can’t change your mind

Can be indexed to maintain pace with inflation

You may get back less than you paid in if you die early

Adaptable to your circumstances (e.g. enhanced annuities)

Inflexible post-purchase — you can’t adjust the income once you’ve bought an annuity

No investment risk1

No chance for pension investment growth if markets perform well1

Provide income for your spouse after your death

Providing spousal income usually means sacrificing initial income

1 : Unless you opt for an investment-linked annuity (see above)

When considering whether or not to buy an annuity, you don’t just have to weigh up the pros and cons of annuities in isolation. You need to look at annuities vs income drawdown as well as all the other options you have for securing a retirement income. This can be confusing, which is why it often pays to speak to an expert.

Annuity vs Pension Drawdown

As mentioned, an annuity is by far the only method you have for turning your pension into a retirement income. Thanks to the new pension freedoms, pension income drawdown is now more widely available than ever before.

New flexi-access drawdown contracts make the full flexibility of pension drawdown available to anyone, regardless of the size of their pension pot.

It’s important to check whether your pension has a guaranteed annuity rate (GAR) before deciding against an annuity. Sometimes, older defined contribution schemes have the option to purchase an annuity at a far more favourable rate than would be available on the open market today.

Benefits of Pension Drawdown

  • Create your own flexible pension
    Manage your own series of lump sum payments and income as you see fit
  • More investment choice
    Choose your investments and the level of risk you’re happy with for your portfolio
  • Benefit from market gains
    By keeping your pension invested, your can benefit from any future growth in the markets
  • Flexible income
    You can adjust the income you’re drawing down to ensure you don’t pay more tax than is required
  • Leave unused pension funds to loved ones
    Capital held within your pension pot can be passed down to your loved ones free from inheritance tax, whereas with most annuities you receive no capital back on death
  • Freedom to change your mind
    You can opt for income drawdown in the early years of retirement and then choose an annuity with the remainder of your pension later if you need to, perhaps to provide a regular income for care home fees.

Negatives of Pension Drawdown

  • Your money might run out
    If your investments underperform, you take too much out or you live longer than expected, your money might run out before you pass away. An annuity, on the other hand, guarantees you an income for life.
  • You’ll likely pay ongoing fees
    As your money remains invested in drawdown, you’ll likely pay ongoing investment management fees in retirement that aren’t associated with most annuities.
  • You’ll face the brunt of market losses
    With most annuities, you don’t leave your pension invested in the market and so there’s no investment risk attached. With drawdown, your pension stays invested so your pension could fall as well as rise and you may get back less than you invested.

How Much Annuity Will I Get From My Pension?

The formula to calculate annuity rates is sometimes expressed in a percentage. So if you have a £100,000 pension pot and you get an income of £4,000 a year, this is classed as an annuity rate of 4%.

The annuity rate is also expressed as the amount you’ll get per £10,000 invested, so a rate of 4% means you’ll get £400 per year for every £10,000 you invest.

How Much Does an Annuity Cost?

Your current annuity rate, or the cost of your annuity, will be based on a number of factors, including:

  • Your age
    The older you are when you buy an annuity the more you’ll receive each year, as the likelihood is you’ll be receiving your income for less time
  • Your life expectancy
    The longer you’re expected to live from the start date of your first annuity payment, the less you’ll receive each year
  • Your health/medical history
    If you’re in poor health you’ll receive a higher income with an enhanced/impaired life annuity, as again you’re likely to be receiving annuity income for less time
  • Your smoker status
    Smokers get better annuity rates than non-smokers because of the life-limiting consequences of smoking
  • Your location
    Your postcode has a bearing on annuity rates because there are considerable differences in life expectancy across the country.

The above annuity factors are fairly limited in terms of what you can do to change your annuity rate. However, there are also a number of decisions you’ll need to make when buying an annuity that will also have an effect on your annuity calculation, such as:

  • Whether you want a single or joint annuity
    Joint annuities, which continue paying to a partner after your death, usually see you get lower income to start with because the likelihood is the income will be paid for longer
  • If you choose an annuity with a guarantee period
    If you choose an annuity with a guarantee period and pass away between the start of your annuity paying out and the end of your annuity’s guarantee period, the annuity will continue paying out until the end of your guarantee period
  • Choice between a level or escalating annuity
    A level annuity will stay fixed over time, running the risk its spending power will be eroded by inflation, whereas an escalating annuity will rise each year to maintain pace with inflation but will result in a lower initial income.

The biggest factors influencing annuity rates are interest rates and gilt rates. Annuities are partially funded by the returns annuity companies achieve on investments, so when interest rates and government gilt rates (also known as UK government debt) are low, as currently, your annuity rate is lower, too.

How Much Annuity Will I Get from a Pension of £100k?

The annuity rates table below contains some examples of the maximum amount per year a healthy individual aged 65 and 75 and with three different size pension pots could expect to receive from a single annuity.

For simplicity, these quotes are for level annuities, meaning they won’t increase over time.

Note that to put this table together we’ve made a number of assumptions:

  • The annuitant is in good health
  • The annuitant has no pre-existing medical conditions
  • They’re a non-smoker
  • They don’t want a guarantee period where the annuity will continue to pay after their death
  • They live in East Sussex, in the same postcode as our Brighton-based financial advisers.

Pension Pot

65 Years Old

75 Years Old


Aviva£5,095.08 p.a.

Aviva£7,393.68 p.a.


Aviva£12,712.68 p.a.

Aviva£18,231.48 p.a.


Aviva£24,613 p.a.

Aviva£36,444 p.a.

Annuity rates represent top quotes and are accurate as of July 23, 2019

This annuity rates table is a handy guide to what the average, healthy individual could expect to receive from an annuity.

However, it’s no substitute for speaking with an expert and getting annuities advice, or requesting your own personalised annuity rates. For that, use our Annuity Rates Calculator or give us a call on 02084327333.

How Are Annuities Taxed?

When you turn your pension pot into a retirement income, you’re allowed to take up to 25% of your pot as a tax-free cash lump sum. This is known in the jargon as your pension commencement lump.

Some people opt to take 25% of their pension upfront as a tax-free cash lump sum and use the remainder to buy an annuity.

Although you don’t have to use the remaining 75% of your pension pot to buy an annuity, you must use one of the options under the other pension freedoms once you withdraw the initial 25%.

If you do buy an annuity, the income is taxable at income at your normal rate of income tax just as if you were earning money from working.

Who Gets My Annuity When I Die?

With a guarantee period annuity and joint annuities, you can pass on annuity income to beneficiaries after your death. This is typically a spouse or partner and potentially dependant children, who will usually receive an income up to the age of 23.

If you die before the age of 75, the income for your dependants will usually be free from income tax. If you die after 75, the annuity income will be taxed as income at their normal rate. Note that inherited pensions, including annuity pensions, are usually free from inheritance tax.

Sometimes you might inherit a drawdown pension pot that hasn’t yet been used to buy an annuity. If you want, you can use the pension pot to buy an annuity after the death of the drawdown pension holder and the same rules apply. If the person dies before the age of 75, the annuity will be paid tax-free. If they die after the age of 75, the annuity income will be taxed as your normal rate.

Expert Advice on Finding the Best Annuity

To get the best annuity rates, you’ll need to do an annuity comparison between the various providers on the market. Drewberry works with a number of the UK’s leading annuity companies to find you a good retirement income proposition.

Don’t just stick with your pension provider if you do decide to turn your pension pot into an annuity. You might well find that another provider will offer you a far better rate.

You could go to the leading UK providers and look for annuity rates from each one individually, or you could use an annuity quote engine such as Drewberry’s. This takes annuity quotes from major annuity providers to help you find a good deal.

Tom Conner Director at Drewberry

The best annuity rates are only available if you shop around. An annuity is a big commitment as you can’t change your mind.

That’s why it pays to get expert advice before jumping in. Please don’t hesitate to pop us a call on 02084327333 or email help@drewberry.co.uk.

Tom Conner
Director at Drewberry

Needed to transfer my pension from one company to another and thanks to Sam it went through very smoothly. Would highly recommend.

Gareth Thomas
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