Introducing annuities

Since Pension Freedoms were introduced in 2015, those 55 or over have more options than ever when it comes to taking benefits from their pension.

Whether you need the flexibility of drawdown, a lump sum for a specific purpose, or a secure regular income, there will be a solution to suit your needs.

While annuities are no longer the ‘default’ option when it comes to retirement planning, they should not be overlooked, particularly if you require a guaranteed income. Below, we explain the key points you need to know about annuities and link to some resources so you can find out more.

"The choices you make at retirement will have an impact for the rest of your life, so it’s important to choose wisely."

What is an annuity?

An annuity is a product from an insurance company that can be used to provide a retirement income. You buy one by paying a lump sum (usually a direct transfer from your pension) to a provider and in exchange, they will provide you with a guaranteed income.

You can use an annuity to fully cover your retirement needs or combine it with other savings, investments, or sources of income. You can even split your pension pot so that part of it is used to buy an annuity and the rest of it can be accessed flexibly.

There are various types of annuities which will suit different circumstances. We explain more below about the options you can include, as well as what to consider when deciding if an annuity may be for you.

One point most people agree on is the need for more clarity and understanding over the retirement options available. The choices you make at retirement will have an impact for the rest of your life, so it’s important to choose wisely. The following video, as well as the free tools we have linked will help you get started.

If you would like to speak to one of our financial planners and receive advice tailored to your situation, please do not hesitate to contact us.

Annuities in 60 seconds

In this short video, Punter Southall Aspire's Chief Commercial Officer Alan Morahan explains what an annuity is and how they work.

Annuities explained

Types of annuities

There are two main types of annuities: lifetime and fixed-term.

How do they work?

Lifetime annuity

As the name implies, these pay a guaranteed income throughout your lifetime. This can offer peace of mind, as there is no risk of running out of money and no ongoing administration to consider.

Fixed-term annuity

Again, as the name suggests, these pay out for an agreed period, anything from one to 25 years . A term of 5 – 15 years is typical. Depending on how this is structured, the income paid out may use up the purchase price in full. In some cases, a lump sum can be provided at maturity, which can then be rolled over into another annuity or used to provide a flexible income. They offer certainty for a limited time without being locked in for life, giving you flexibility at the end of the fixed term.

Within these two main types, there are a number of additional options that can be built in. These are mainly relevant to lifetime annuities, but there are some situations where it might also be appropriate for a fixed term annuity. These options are explained below:

Enhanced annuities
Joint life annuities
Escalating annuities

Enhanced annuities, also known as an impaired life annuity or enhanced pension annuity, pay out a higher income if your health or lifestyle is likely to shorten your lifespan.

For example:

If you smoke, are overweight or have an existing health condition, and provide proof of these factors to your annuity provider, your annuity income is likely to be higher than that available from a non-enhanced annuity.

Be sure to check with any provider whether you are eligible for an enhanced annuity, as the income rates could be substantially better than a standard annuity.

You can check annuity rates, including any health and lifestyle factors that apply, at Pension Potential.

our lifetime. This can offer peace of mind, as there is no risk of running out of money and no ongoing administration to consider.

A joint life annuity provides a guaranteed income either to the person who takes it out (the ‘annuitant’) or their beneficiary (the ‘joint annuitant’). The beneficiary would normally be your spouse or partner – this ensures that they will have some financial security if you die before them. A joint life annuity may suit a couple if  the annuitant has significantly more pension provision than their beneficiary.

You can select the amount from your original annuity income you would like to be paid after your death.

For example:

If you decide you want half your annuity income payments to be paid to your beneficiary after your death, you’d select a 50% joint life annuity. Similarly, if you want the whole of your annuity income to be paid to your selected person after your death, then you’d choose a 100% joint life annuity.

You usually receive a joint life annuity at a lower rate than if you selected a single life annuity. This is because the insurer may need to pay benefits for longer, particularly if your partner is younger than you.

This means the amount of annuity income you receive from the beginning of your contract is lower. Choosing a larger percentage of annuity income to be paid out after your death will reduce it further.

Once you have selected a joint life annuity, you can’t change your mind after the cancellation period expires, even if your circumstances change or your partner pre-deceases you.

If you are unsure if a joint life annuity is for you, speak to one of our financial planners for more information. We do not charge for a first meeting. If we make a recommendation, the costs will be clearly explained to you before you proceed.

A concern for many retirees is that if they die in the early years of buying an annuity, they (or their family) may receive less back in income than the amount paid for the annuity.

One solution for this is to build in guarantees or value protection. This works as follows:

  • A guaranteed period, for example, 5 or 10 years, means that if you die within that time, the insurer will continue to pay out income due for the rest of the guaranteed term (or an equivalent lump sum).

  • Value protection means that you can choose to protect a portion of your annuity purchase price, for example, 50%. If the amount paid out in income is less than the protected amount, the difference will be paid out as a lump sum.

Like joint life annuities, adding these guarantees will reduce the amount of income you receive from the start.

With the cost of living on the rise, you may wish to consider inflation protection as part of your retirement plan.

Annuities can be taken out on a level basis; in which case the income amount will remain the same every year. Alternatively, you can choose an escalating annuity which means that your income will increase. You can choose a fixed rate of escalation (for example, 3%), or link your income to the rate of inflation, although, this will normally be capped.

An escalating annuity can provide some protection against rising costs. However, if you choose an increasing annuity, you will receive a lower income at the start than if you opted for a level annuity and it may take several years for the total amount paid out to catch up. The best option will depend on your circumstances and any other sources of income or capital you have.

You can include any of the above options, alone or in combination, when you buy your annuity. Remember, an annuity that includes a beneficiary’s pension, guarantees, and annual increases will pay out a lower income than a level annuity with none of these options selected. It’s a good idea to think carefully about your requirements and compare rates from different providers before making a decision.

Case study

Some ways we've
helped our clients

Annuity purchase for a risk-averse client.

Read the case study

What about tax?

When you are ready to take benefits from your pension, you can withdraw up to 25% of your pot as a tax-free lump sum. Some pre-2006 occupational pensions may even allow you to take more than this. You can withdraw your lump sum all at once or use it to supplement your income over a period of years.

The remaining 75% of your pot will be designated to provide an income – an annuity is one of the options you can choose. If you are buying an annuity with your accrual pension, you will need to take your tax-free cash at around the same time as your income (they need to be within 12 months of each other). If you don’t need all the money immediately, you can keep it in a savings or investment account.

Your annuity income is taxed in the same way as a salary, via Pay as You Earn (PAYE). Your pension provider will send you pay slips and an annual P60. This can keep things simple, as your tax is deducted automatically and you may not even need to complete a tax return (unless you have other income).

If you die before age 75, any death benefits included within your annuity (such as a beneficiarys pension or guarantees) will be paid out free of tax. If you die after age 75, your beneficiaries will be taxed at their personal rate on any income or lump sums received. While pensions are not normally subject to Inheritance Tax (IHT), any payments under a guaranteed period may be included within your estate.

Purchased life annuities

The tax rules are different if you purchase your annuity using cash rather than a pension pot. This type of annuity is less common, but may still be used in some circumstances, for example, to pay for long-term care.

In this scenario, the regular income comprises a return of your own capital as well as an interest element. Only the interest is taxed as savings income.


Why buy an annuity?

Benefits of buying an annuity:

  • An annuity can offer you a regular income for life or a fixed term as required. This can supplement your State Pension, as well as any other income or capital you have.

  • You can be certain that you won’t run out of money, even if you live longer than expected.

  • You can build in various options to provide for your loved ones if you die.

  • You can also include annual increases if you choose to.

  • You may be able to secure a higher income if you have any health or lifestyle factors to take into consideration.

  • The tax treatment is straightforward and the routine administration is minimal.

There are, of course, some downsides to buying an annuity:

  • The amount of income may look low relative to your pension pot, particularly if you build in extra options such as a joint life annuity or escalation.

  • You may value flexibility over the certainty of a regular income.

  • Once your annuity has started and the cancellation period has expired, you can’t change your mind about the options you have chosen.

  • Unless you build in death benefits, your annuity could stop when you die.

  • Annuity rates might go up or down, which means you can’t be sure you have locked in the best rate.

Pension Potential

An expert service for maximising your pension pot’s potential.

Top tips

Buying an annuity 

You don’t have to buy an annuity from the company which provides your pension. You have the right to check out every deal on the market (this is known as the ‘Open Market Option’) to find out what others are offering.

Be sure to shop around the entire market to find the best deal to suit you.

Some tips...


Begin by talking to your pension provider to see what they are offering, as they may still offer a higher rate than other companies.


Make sure you disclose any health or lifestyle information, as this could improve your rate.


If you’re unsure about whether or not to go with your pension provider, window-shop for the best deal - known as the open market option. Pension Potential is one tool which helps you compare EVERY deal out there.


If you’re still not sure, there’s a wealth of online guidance that could help. If you want more concrete advice, you can talk to a financial planner (note that this may incur an advisory fee).


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