What is an Annuity?

What is an Annuity?

Creating a regular income on retirement...

An annuity is a financial product that converts a lump sum saving into a regular annual income. Most people choose to buy an annuity with their private pension savings on retirement, often after taking a tax-free lump sum (up to 25%) from their pension pot. Savings of £100,000 or more are usually required to purchase an annuity.

Annuities are popular because they provide a known and guaranteed annual income for the rest of your life. You know how much you’ll get each year and are able to budget and enjoy your retirement without worrying about a fluctuating income.

The amount you receive depends on the rate set by the annuity provider and the size of your pension pot (after the tax-free lump sum, if you’ve chosen to take it) at the time you buy your annuity. The annuity provider will quote a percentage rate, which you multiply by your pension savings to calculate your expected annual income. For example pension savings of £200,000 at a rate of 6% will provide £12,000 per year. Further examples are shown in our comparison table below, this should give you an idea of how large a pension savings pot you need for your standard of living.

Increase your annual retirement income with an annuity...

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Rate to income comparison table:

Pension Savings Annuity Percentage Rate Annual Income
£100,000 6% (rates vary) £10,000
£250,000 6% (rates vary) £15,000
£500,000 6% (rates vary) £30,000
£1,000,000 6% (rates vary) £60,000
£1,500,000 6% (rates vary) £120,000

Rates vary year on year and depend on your personal circumstances such as your gender, age, postcode and health as well as the performance of the annuity provider’s investments at the time you retire. The healthier their investments the better the rate you’ll be offered and vice versa. Rates are generally falling because we are living longer and providers are therefore paying out for longer.

People with a defined contribution workplace pension or a personal pension can buy an annuity. If you have a final salary or defined benefit pensions you are paid an income directly so there’s no need to invest in an annuity. The pension trustees of some workplace pension schemes may buy an annuity for the pension holders, but you would not have any input into which one. It is possible to buy an annuity with savings but pension annuities are the most commonly purchased.

Once you’ve bought your annuity you can’t switch to another provider for a better rate or move your money to an alternative savings scheme even if your personal circumstances change. The most commonly annuity is a conventional or standard annuity which comes with several options including single or joint policies and level or escalating incomes – all options have their pros and cons. There are also annuities for people in poor health known as enhanced annuities and fixed-term annuities for those who wish to invest on a shorter-term basis. It’s important to research the market well and be sure you chose the annuity best suited to you.