Annuities explainedProblem solvers

You will need to work out what your financial priorities are

With any annuity you exchange a lump sum for an income payable for the rest of your life. However, the type of income you decide to have will make a big difference to the amount you receive.

The main factors to consider are:

• Whether you want protection against inflation during retirement
• How much risk you are prepared to take
• Whether anyone else is dependent on you
• How much flexibility you need to change your pension after it has started to be paid
• How much control you want over your investments
• What charges you will need to pay
• Whether you want to provide an inheritance for your survivors.
• What your general state of health is and whether you are or have been a smoker.

A level or an increasing income?

To work this out you will need to decide whether or not you want your income to increase each year. You can buy an annuity that increases with inflation, or one that's set to rise by a fixed percentage each year. Alternatively, opt for a level annuity, which will provide exactly the same income each year.

Level annuities

Level annuities are the most popular type, probably because they offer the highest starting income, but they do leave you vulnerable to inflation. Remember that 4% rate of annual inflation will halve the buying power of an annuity in 18 years.

However if you buy an annuity with protection against inflation you'll have to accept a lower starting income. Although your income increases over time, it might be many years before it catches up with a level annuity.

Increasing annuities

You probably need to think about your plans for retirement before deciding whether or not you want an increasing annuity. Do you want to maximise your income during the early, healthiest years of your retirement, or do you want equal purchasing power over the years?

It's important that you decide whether your pension will protect your partner as well

Your answers may depend on your health and how long you expect to live. If you have an existing medical condition, you may be able to get an even higher rate with an enhanced annuity (see Impaired/enhanced annuities below)

Single or joint life?

The next decision is whether you want an annuity that covers you alone, or one that protects your partner as well.

A single life annuity pays you an income until you die, but if you're part of a couple and die first this could mean that your partner is left short of money. A joint life annuity continues to pay some or all of the annuity income to your partner when you die.

There are of course some trade-offs for this extra provision. Because a joint life annuity will continue to be paid after you are dead, the rates offered are lower. The higher the proportion of your annuity income that you choose to be paid after your death, the lower the initial income paid by your policy.

And if your partner is younger than you, the insurance company will offer a lower annuity rate as they expect to be paying out for longer.

Guarantees

Where an annuity has a guarantee period, it will be paid out for a set time period, usually five or ten years, even if you die during that time. If you do die during the guarantee period, the payments may continue as an income to your survivor(s) for the remainder of the period, or sometimes can be rolled into a lump sum.

An annuity with a guarantee is sometimes seen as a substitute for a joint life annuity. But it's not the same as the maximum guarantee period is only ten years. As a result, it won't fully protect your dependants in the long-term.

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