Yellow circle

Have you heard of annuities but don’t know exactly what a pension annuity is? At Annuity Ready we help UK residents aged over 55 with a pension pot of over £2,000 (before any tax free cash has been withdrawn) compare lifetime annuities so we know a thing or two about the types of annuities available. In this guide we answer the question, ‘What is a pension annuity?’ and more.

What is a pension annuity?

A pension annuity is a kind of retirement income product that can be purchased using part or all of your pension pot. It is just one of the ways you could choose to use your pension savings in retirement. Once in payment the pension annuity will provide you with a regular, guaranteed income for the rest of your life or for a fixed period (usually five to ten years). It is important to consider if an annuity meets your needs as once you buy an annuity, you can’t change your mind.

How does a lifetime pension annuity work?

You can buy a pension lifetime annuity using some or all of the money in your pension pot. At the point of purchasing your pension annuity, you can normally choose to take up to 25% of your savings (of the amount you’re allocating to buy your annuity) as a tax-free lump sum that you can spend however you wish. The money you choose to take out of your pension pot as tax-free cash will reduce the amount left to purchase your annuity and will therefore impact the amount of income you will receive.

Like most income, the annuity payments you receive will be subject to income tax. The annuity provider will normally deduct the tax based on your tax code, before paying you the net income. When purchasing your annuity, you can select your payment frequency typically choosing to be paid on a monthly, quarterly, half-yearly or annual basis. You can also choose to have your payments at either the start or end of your chosen payment frequency and you will usually receive a higher income if you choose to be paid at the end. You may also receive more income by opting to be paid annually instead of monthly or quarterly.

When buying your pension annuity, you will be able to tailor your options to meet your needs, and if selected, those of your nearest and dearest. For example, by choosing a joint annuity you could give a guaranteed income to your named spouse or partner for the rest of their life if they outlive you.

Additionally, you could consider adding death benefits. For example, one way to provide for your loved ones after you die is to opt for value protection which allows you to protect some, or all of the pension fund used to purchase your annuity, meaning you could leave something behind after your death. Alternatively, if you select a guarantee period, this would ensure your annuity income is paid for a specific length of time.

You could choose to have your annuity income increase annually to keep up with inflation or by a fixed amount. To increase your income, you can choose to have the same amount payable for the life of the annuity.

You should bear in mind that adding some of these benefits to your annuity can have a significant impact on the level of income you will receive.

What are the different types of pension annuity?

There are different types of pension annuity with the most popular types available in the UK being lifetime annuities and fixed term annuities. A lifetime annuity is a financial product that pays you a guaranteed income for the rest of your life in exchange for some or all of the money in your pension pot.

A fixed term annuity is similar to a lifetime annuity but pays an income for a fixed period of time, or until you die if this is earlier. At the end of the fixed period, you can use the maturity amount to invest in another retirement income product or take your money out of your pension.

At Annuity Ready we help you compare pension lifetime annuities including joint life annuities. You’ll also be able to add death benefits like guarantee periods and value protection as well as escalating income to see the effect these could have on your annuity income. Find out more about the different annuities available in our guide, ‘What are the different types of annuity?’.

What is the difference between a pension and an annuity?

You save money into a pension throughout your working life along with any pension contributions from your employer to create a lump sum to help support yourself financially in retirement. An annuity can be purchased using these pension savings to provide you with a regular, guaranteed income for the rest of your life.

Do I have to buy an annuity with my pension?

Since the recent introduction of new pension freedoms those over the age of 55 have more choice around how they use their pension pots. Therefore, you do not have to buy an annuity with your pension, and you are free to shop around and find the right retirement product for your circumstances. You may wish to seek advice before you decide. Learn more in our guide ‘Do I need to seek advice before I buy an annuity?’.

Does a pension annuity die with you?

Payments from a pension lifetime annuity will end when you die unless you have selected specific death benefits, or you purchase a joint life annuity, and your partner outlives you. Find out more in our guide ‘What happens to my annuity after I die?’.

Are pension annuity payments taxable?

Yes, annuity income payments are subject to income tax. If you purchase a pension annuity your annuity provider will normally deduct the tax based on your tax code before paying you the net income. Often the income is initially set up with an ‘emergency tax code’ so your first income payment may be lower before the correct tax code is used. National Insurance contributions will not be taken from your annuity income.

Why buy a pension annuity?

A pension annuity may be right for you if you need, or would prefer, a guaranteed income in retirement. One of the main advantages of buying a pension lifetime annuity is that you will not outlive your money. Once you have bought a lifetime annuity it will provide you with a guaranteed income for the rest of your life, so you will have an income until you die.

Once purchased, your annuity rate will be fixed (unless you have chosen for it to increase in line with inflation, by a variable amount up to 5% or by a fixed amount up to 10%) and your annuity income will not normally be affected by changes to annuity rates or, unlike income from pension drawdown schemes, stock market volatility. However, buying a fixed annuity will mean that inflation will impact your purchasing power and you will not benefit from any increases in the stock market.

Buying a pension annuity could be beneficial if you are in poor health, are overweight, smoke or suffer with certain medical conditions. This is because you may be eligible for an enhanced annuity which will provide you with a higher income compared to a standard rate annuity and will be payable for the rest of your life, even if your health improves. Find out more about the benefits and downsides of purchasing a pension annuity in our guide, ‘Reasons to buy an annuity’.

How can you compare current pension annuity rates?

You can compare current pension annuity rates from all providers in the annuity open market including Aviva, Canada Life, JUST, Legal & General and Scottish Widows with our online comparison tool. This will allow you to see if you can get a higher income than you are offered by your current provider and adjust your options to see how they affect the annuity income you are offered. Simply enter your details once and compare annuity quotes now.

How can you buy a pension annuity?

Once you have compared pension annuity rates and are ready to purchase an annuity simply login to your Annuity Ready account where your details have been stored to complete the purchase or contact our customer service team to obtain your application pack. Learn more about the process of buying an annuity in the guide ‘Buying an annuity: a step-by-step guide’ or get or retrieve quotes with Annuity Ready.