An annuity is a type of ‘life policy’ which enables the policyholder to enjoy a regular income in exchange for a lump sum of cash which is commonly built up through a pension scheme. Once the annuity has been bought the contract cannot be reversed – the pension fund 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 value of your pension fund at retirement
- The prevailing annuity rates at the point of annuity purchase
In general, with all else being equal, the older an annuitant the higher the income which can be secured.
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 percentage 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’