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Purchasing an annuity with your pension fund is a big decision so it’s important to understand how annuity rates are calculated and why you may be offered the annuity incomes you see when comparing annuity quotes.

In order to calculate annuity rates, providers consider a combination of the following factors:

The size of your pension pot

The main thing that will affect the annuity income you are offered is the size of the pension pot you allocate to purchase the annuity. The higher the value of this pension pot, the higher your annuity income will be.

When purchasing a lifetime annuity, you will usually have the option to take up to 25% of your pension savings (or of the amount you’re using to buy an annuity) as a tax-free lump sum, to spend however you wish. The more you choose to take as tax-free cash, the less you will have available to put towards your annuity and therefore, the lower your income will be.

To find out how much your pension is worth you’ll need to check your most recent pension fund statements or speak to your pension provider(s).

Your age

Pension lifetime annuities are available to those aged between 55 and 84 years and 9 months. The younger you are when you buy an annuity, the longer the provider will have to pay you an income. This normally means that the income paid to a younger person would be less than the income paid to an older person from an annuity bought with the same amount of money at the same time.

For example, if you are aged 60 with a retirement pot of £100,000, you will receive a higher income than someone aged 55 years, assuming you choose identical annuity options at the same time and you are both in good health.

Your health

The longer your life expectancy, the longer your annuity provider will have to pay you an income.

If you have, or have had, certain medical conditions, you may be eligible for an enhanced annuity which will provide you with a higher income for the rest of your life, even if your health improves. Lifestyle factors including smoking and obesity may also mean you qualify for an enhanced annuity, so it’s important to answer all questions completely and honestly at the quotation stage.

To find out more about enhanced annuities see our guide ‘What is an enhanced annuity?’ or complete the quote form to see if you’re eligible for an enhanced annuity income.

Your choice of single or joint life annuity

If you have a spouse or partner you may want to consider purchasing a joint life annuity. A joint life annuity will give you a guaranteed income for life, a portion of which will then transfer to your named spouse, registered civil partner or financially dependent partner if they are alive when you die. Selecting a joint life annuity rather than a single life annuity will normally reduce the amount of income you receive as the provider will potentially have to pay an income for longer.

Our guide ‘single vs joint life annuities’ includes more information on the difference between single and joint life annuities and what happens when you die.

Your selected death benefits

You can choose to add a death benefit to your annuity, either a guaranteed minimum payment period or value protection. These will affect the annuity income you are offered. If you do not select an annuity with a spouse or partner’s income (a joint life annuity), no payments will be made after your death unless you have added a death benefit. Death benefits are available for both joint and single life annuities.

Guarantee periods

A guarantee period can be added to your annuity to ensure payments are made for a specific length of time. This means that if you purchase a lifetime annuity with a guarantee period and die early, your annuity will continue to pay an income to your beneficiaries or estate after your death for the remainder of that period. The longer the guarantee period, the lower your annuity income is likely to be as the provider is guaranteeing to pay the income for the minimum period set.

To learn more about guarantee periods take a look at the answer to the question ‘What is a guarantee period? (Also known as a minimum guarantee period)’ in our ‘Frequently asked questions’.

Value protection

Value protection is another death benefit that you can add to your annuity. It allows you to protect all or part of the pension fund used to purchase your annuity. It does this by returning a lump sum to your estate if you (or if selected, your spouse or partner) die without having received the pre-selected protected portion of your original pension pot less any income already received. Adding value protection to your annuity will mean your annuity income will be lower than it would have been if you chose not to add any protection.

To find out more about value protection have a look at our ‘Frequently asked questions’ and view the answer to the question ‘What is value protection?’.

Your escalating income

When purchasing an annuity you can choose to have it increase annually to try and keep up with inflation by either a fixed increase up to 10%, the Retail Price Index, or a variable amount up to the lower of 5% or Retail Price Index (also known as the Limited Price Index). The greater the increase you select, the lower the annuity income will be initially, and it may take several years for the escalating income to reach the same level as you would have received through a non-escalating annuity income.

To learn more about escalating income (also known as escalating annuities) have a look at our guide, ‘What are the different types of annuity?’.

Market conditions

Another consideration for providers when calculating annuity rates is the state of investment markets and their view of future investment returns. Factors such as the Bank of England base rate have an effect as when base rates are low, annuity rates tend to be low too. This is because annuities are partly funded by the interest earned on your money when it’s invested, so if rates are low you will usually be offered a lower income.

The value of government bonds (known as gilts) also play a part as providers usually purchase these as a way to part fund annuities. Once purchased, the government pays annuity providers a fixed amount of interest which is tied to the Bank of England base rate and inflation. When the base rate and inflation are low, gilts become more expensive and the returns received are reduced, which affects the annuity rates providers offer.

Find out how much annuity income you could get

If you would like to find out how much annuity income you could get, you can use our online form to compare annuity rates from all providers in the annuity open market. If you’re ready, compare annuity quotes now.