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Why annuities can still be useful in retirement planning

Why are annuities still relevant today? Despite the increase in pension flexibility in recent years, an annuity remains a fitting option for many people based on one certainty: The income is guaranteed to be paid for life.

What is an annuity?

What is an annuity?

A pension annuity is a contract issued by a life assurance company in which you give up your pension pot fully or partially in exchange for a guaranteed regular income over a set term. There are two types: guaranteed income and non-guaranteed income.

Guaranteed income

Lifetime annuity - level

A fixed amount per year that will not change for the rest of your life


Lifetime annuity - increasing

Income increases each year by a fixed percentage for the rest of your life


Lifetime annuity - index

linkedIncome increases each year in line with inflation for the rest of your life

Non-guaranteed income

Unit-linked annuity

Income is linked to the performance of one or more investment funds

With-profits annuity

Income is linked to a With Profits fund, giving the potential for annual bonuses

The term for your secured income can vary from one year to an entire lifetime: if you only need guaranteed income for a short period, or you would prefer not to commit to a lifetime annuity then you do not have to exchange your pension pot in one go and can instead use part of your pension pot to purchase a short-term annuity.

What are the advantages of annuities? 

Although you may prefer the control that options like flexible drawdown give, secure income from a pension annuity will give you the assurance of certainty in your retirement planning. Here are some reasons you might consider purchasing an annuity: 

  • You are very uncomfortable with investment risk, financial loss, or are otherwise cautious with your money;

  • Your retirement provisions are insubstantial and you cannot afford your pension income to fluctuate;

  • You need a guaranteed income for a fixed and regular expense;

  • You do not want to think about managing investments whilst in or nearing retirement;

  • Your life expectancy is particularly long. The further into the future you look the cloudier it will be: annuities provide certainty here;

  • Or, you have a lower life expectancy, perhaps caused by a medical condition, and therefore your annuity rate and thus your income will be higher than average.

What are the advantages of annuities?

What are the disadvantages of annuities?

Although annuities offer security, their primary disadvantage is that they are inflexible. These are some of the reasons an annuity might not be suitable for you: 

  • Annuities are irrevocable - once purchased, you cannot reverse the decision and get back your pension back.

  • Because you exchange your pension fund for an annuity, you lose all the flexibility to access your pension pot in the most suitable way for you.

  • Annuity income is taxed as ordinary income, and because payments are secure, you could be forced into a higher tax bracket, depending upon other taxable income.

  • Annuity rates have been on a downward trend over recent years, so the amount of income your pension pot can buy you with an annuity is at historic lows. 

  • Annuities are complex, with providers offering many variations and add-ons. Fees are often opaque and contracts have many rules and limitations.

  • The add-on features, such as indexing, or spousal survivor benefit, will reduce the annuity rate given, therefore reducing the income you receive.

  • Unlike pensions, annuities cannot be used as a legacy planning tool. Apart from spousal survivor benefits, the annuity will cease on your death.

Since annuities are irrevocable contracts the decision to purchase one with your pension pot should not be taken lightly. You should consult an Independent Financial Advisor, who can present the alternatives to you in a quantifiable way, based on your particular circumstances and objectives. A guaranteed income may sound appealing, but if this is projected to be one-third of the projected income you could earn from a drawdown pension, how would that affect your decision-making? The best thing to do is arm yourself with all the correct information so that you can make an informed choice. 

What are the disadvantages of annuities?
How are annuities taxed?

How are annuities taxed?

Annuity income is taxed as pension income, which is taxed at your marginal rate of income tax. Annuity income can make use of your personal allowance too (currently £12,570 for 2021/22) meaning, with your other income streams, you can receive this amount each year tax-free. 


When you purchase an annuity from your pension fund the cost of the purchase will be tested against your lifetime allowance if this is the first time you have accessed or drawn money from the pension plan (and just the growth is tested if the funds are already in a drawdown plan).


This may mean there is some tax to pay if you are over your allowance.


Remember: At retirement check what band of income tax you are in as this may have changed if you are no longer employed.

How do you choose the right annuity?

You need to decide on the level of security you want as the main characteristic of a typical annuity is that the income is guaranteed.


If you want some investment exposure then you can purchase a unit-linked or with-profits annuity, however the income is non-guaranteed.


Once you reach the minimum pension age (currently 55 and it is intended that the minimum pension age will increase to 57 from 2028) you have the right to buy an annuity from your current pension provider or from the open market.


On deciding how an annuity can contribute to your retirement income, you then have full control over how the annuity is set up. You are able to decide:

  • The frequency of income from monthly to annually; in advance or in arrears

  • The term length that you receive guaranteed income

  • Whether you want any annuity protection

  • Whether you want any survivor’s annuity upon your death. This means you can secure a percentage of your annuity to be paid to a dependant or nominee


Remember: Annuities are irrevocable contracts: once in force they cannot be cancelled or reversed.

​How do you choose the right annuity?
​How much income will an annuity pay?

How much income will an annuity pay?

There are three factors that determine how much income you can get: the size of your pension pot; your life expectancy and annuity rates (largely determined by gilt yields). 

  1. The size of your pension: the bigger this is, the more income you can receive;

  2. Your longevity: the greater your life expectancy, typically the less income you are likely to receive. If you have a shorter life expectancy or medical condition then you can obtain a better annuity through what is referred to as impaired life or enhanced annuities;

  3. Annuity rates: the rate you will receive will be influenced by the former two points, however underlying rates are determined by gilt yields. The greater these are the better rates that can be offered by insurance companies.

What does an annuity cost?

Costs vary depending on the provider, however, typically they are referred to as: Establishment fee (charged when the annuity is set up); Management fee (mainly where you choose an investment-linked annuity), and Insurance fee (for any guarantees with your annuity). 

You may have to cover extra fees depending on whether there is any underwriting needed, or any adviser fees levied. TPO will clearly show any initial and ongoing charges in pounds and pence and, where necessary, explain why any alternatives have been discounted.

What does an annuity cost?

What is the next step? 

Pensions are complex and you need to ensure that you are armed with the correct information, based on your personal circumstances and objectives, in order to make an informed choice when choosing, or transferring, any pension plan. It is recommended that you take professional financial advice to ensure that you have the correct plan to meet your needs and that you are on track to meet your retirement goals.

Connect with an expert through our network of UK-qualified Independent Financial Advisors. Through our introduction, you will be entitled to a free, no-obligation pension review. 

What is the next step?
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