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Annuities are used to provide a pension income, in the case of pensions this income is guaranteed for life. The pension fund is exchanged for a pension income. Once the annuity has been bought, the income is fixed, the contract cannot be reversed - the pension lump sum becomes the permanent property of the annuity provider.

The level of income that you will receive from an annuity depends upon several main factors:

  • The level of Investment
  • Age of 'annuitant'
  • Health
  • Sex
  • The prevailing annuity rates at the point of annuity purchase

In general, the older an annuitant higher the income which can be secured. Furthermore males usually receive a higher income than females due to generally have a shorter life expectancy.

However a new european wide law could prevent providers from discriminating by gender in the future

How They Work

Annuities, in the main, are supplied by Life Assurance Companies. The underlying 'annuity fund' is usually invested in fixed interest investments, such as long term government gilts in order to maintain the guaranteed income and ensure regular income payments are made to annuitants.

Annuities can be set up to provide different benefits / options:-

  • Spouses pension (to protect a spouse, by providing an income, following the death of the annuitant)
  • Guaranteed payment periods; 5 years is typical but 10 year guarantees are possible
  • Escalation of benefits; income can be protected from inflation - RPI linked escalation, alternatively a fixed % annual increase in income can be secured at outset e.g. 5%
  • Annuity income can be linked to investment performance for example by a 'With Profit Annuity' or 'Unit Linked Annuity'

Since April 2011 investors have the freedom to choose when and how they take their pension with the compulsory annuity age of 75 being withdrawn.

It is important to understand the options available to you when you buy an annuity. Like all things, there are pros and cons to each. Which option suits you depends on your circumstances and attitude to risk

Level Annuity

Income will not increase in payment. It provides the annuitant with the highest attainable income from outset compared to other options. However, as lime goes by and inflation sets in, the value of the pension, in real terms, decreases. In the case of someone who reti res early and then lives a long time, this reduction in 'buying power'could be considerable.

Joint-Life Basis

With this option, either a full or reduced income will continue to be paid to the partner if the annuitant dies. Because women tend to live longer than men, a wife several years younger than her husband could reduce the income payment offered at outset significantly. Joint life annuities are usually taken out by married couples, especially when the spouse has no other independent pension income.

Guaranteed Annuity

It is possible to ensure that the income to be paid is guaranteed at a set level for a period of time after the death of the annuitant. Typical guarantee periods may be 5 or 10 years. This option will almost certainly reduce the starting income.

If the annuity is on a joint-life basis and both parties die within the guarantee period, the payments will continue to be paid to the deceased annuitant's estate.

Escalating Annuity

These provide an income that will increase annually at a predetermined rate, or sometimes in line with the retail price index. The advantage of this is the income provides some protection against inflation. However, the initial starting income will be reduced in comparison to a level annuity.

With or without overlap

Applicable when a joint life guaranteed pension has been chosen. With overlap, the spouse/dependent's pension will commence immediately upon the annuitant's death. Without overlap, the pension will commence at the end of the guaranteed period or immediately upon the annuitant's death, whichever occurs latest.