By Paul Davies
Article 2 of 5
Find out about the different types of annuity that you can choose, and the pros and cons of each option.
Annuities come in all shapes and sizes, but it's vital that you pick the right one – because once you buy, you can't change your mind.
Since April 2015, you've been able to withdraw as much of the money as you want when you reach 55 as another option, although it will be taxed as income.
You'll have to weigh up a number of options that will influence which type you end up buying – if an annuity is the right choice for you.
Key things you should consider when deciding on your pension options (eg an annuity, income drawdown or cashing in your pension) include:
- whether you want protection against inflation
- how much risk you’re prepared to take
- whether anyone else is dependent on you for income
- 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'll need to pay
- whether you want to provide an inheritance for your survivors
- what your state of health is, and whether you are or have been a smoker.
If you opt for an annuity, always shop around before purchasing. It's an irreversible decision, so seeking advice from an independent financial adviser could also help you secure the best deal.
The different types of annuity
This guide outlines the different types of annuity and what you'll get from each.
Level annuities pay out a flat, or 'level', amount of income every year for the rest of your life. The advantage of this type of annuity is that you get the highest rate possible at the start. However, inflation will eat into this flat rate of income over time, meaning you won't be able to buy as much with your money in later years.
These pay out an increasing amount each year. You can opt for a specific percentage increase each – say, 3% – or in line with inflation. The latter is usually pegged to the Retail Prices Index (RPI).
Escalating annuities protect your retirement income from inflation, but they're expensive. When you first buy one, the income you'll be paid is likely to be around half that of a level annuity, and it could take as much as 20 years for you to be paid more than a level annuity.
Single-life annuities – meaning that the income is paid only to you – account for around two thirds of all those sold, but if you have a partner who might outlive you, it can cause problems.
You could buy an annuity with a guarantee, which will carry on paying out for at least five or ten years after you buy it, even if you die during this period. But the best way to provide for a surviving partner is to buy a joint-life annuity.
These annuities pay you an income then, after you die, an income to your partner or spouse until they die.
You can set the amount that is paid after the first death at 100% (the same as the initial rate), or 66% or 50%. The starting rate is lower than for a single-life annuity, but a joint-life annuity could end up paying out more in the long run.
The payouts from these are tied to the stock market, so the amount they give you varies depending on the success of underlying investments. They start by paying an initial annual sum that then rises or falls in subsequent years.
Variable or flexible annuities
Like investment-linked annuities, these rise or fall in line with investments. However, they have a guaranteed minimum, so you have a degree of certainty, but they're complex products and are not right for everybody.
Fixed-term annuities are like standard annuities in that they pay a set amount each year. However, they stop after a certain period (normally five or ten years) and, on maturity, they pay out a capital sum, which you can use to purchase a standard annuity or invest it in another product.
You aren’t locked into a single rate for life and you can shop around for a better deal later on.
Standard annuities are based on average life expectancy, currently 84 for men and 86 for women. But not everyone lives this long, so some providers offer enhanced annuities to people in poor health or with lifestyle conditions that mean they might die earlier. They’re worth considering if you've been ill – you can increase your annuity income by as much as 50%.
Go further: Enhanced annuities, has more information on how these work
- Last updated: January 2017
- Updated by: Paul Davies