Annuities Annuity types
Choosing one particular annuity over another could give you more in the long run
Value protected annuity products
April 2006 saw the introduction of value-protected annuities – a more explicit version of a guaranteed annuity.
With a value-protected pension annuity, if you die before age 75, your built-up fund is returned to your estate less any income that has been paid out, and 35% tax.
Impaired and enhanced life annuity products
As annuity rates are tailored to average life expectancy, some companies will offer a higher annuity rate to those with a lower life expectancy – if you have a health problem, for example. These are known as ‘impaired life’ or ‘enhanced life’ annuities.
It is estimated that up to one in three of us could qualify for an impaired or enhanced life annuity. You might qualify for an impaired or enhanced life annuity if you have severe health problems, such as a history of heart disease or cancer. They may also consider a higher annuity rate for heavy smokers or people who are overweight.
You usually have to go through an independent financial adviser to get one, and the application process can be lengthy – impaired and enhanced life annuities are individually underwritten and you'll probably need medical information from your GP, as well as extra tests.
Investment-linked annuity products
Investment-linked annuity products will allow you to tap into any potential returns you may not receive if opting for a more standard annuity.
You still have to hand over your fund in return for an annuity income, but you stand to benefit from future stock market growth. Be warned that, as with all stock market-linked investments, there are no guarantees that annuity returns will improve or that your income will rise.
With-profits annuity products
These work like any form of with-profits investment. The returns on your investment are smoothed out over time. In good years, some of the annuity return is held back, allowing more to be paid out in bad years.
When you take out a with-profits annuity, you choose an anticipated bonus rate (ABR). The level of your income depends on how the ABR compares with the level of bonus the insurance company declares. If you choose an ABR of 3%, and the company declares a 5% bonus, then your income rises. If the declared bonus is only 1%, your income falls.
Annuities with the highest ABRs pay the highest initial incomes, but the higher the starting income, the less chance there is that it will increase in future.
Do some thorough research to make sure you're happy with your choice of annuity
For added security, some with-profits annuity products offer a minimum guaranteed income, regardless of investment growth.
Unit-linked annuity products
With unit-linked annuities, your money is invested in a unit-linked pension fund which works along the same lines as a unit trust. Your income varies depending on the value of the stocks, shares and other assets that your units represent.
You can switch between your provider's different funds if you want to change your investment strategy. But remember that switching funds can mean higher costs. Experienced investors might prefer a self-invested unit-linked annuity, which gives you more control.
Unit-linked annuities are more volatile than with-profits annuities because your investment returns aren't smoothed out over time. You should consider them only if you have a very adventurous attitude to risk, can cope with a fluctuating monthly income, and have other sources of income.
Purchased life annuity products
While this annuity will give you an income for life, this is not a pension annuity – one you buy with money from your pension pot. You buy it using a cash lump sum, your savings, for example. However, your options are limited to a conventional annuity as opposed to an investment-linked one.
As with all conventional annuities you have to decide whether or not you want your income to rise, and whether or not you want the annuity to just cover you, or a partner as well.
A big difference is that you can choose to buy a purchased life annuity where your capital is fully protected rather than just a guarantee. Taking one of these out means that when you die, the remaining annuity money is repaid to your estate and so can be passed to your heirs. However, if the gross income paid out is greater than the amount invested, your heirs receive nothing.
Tax on purchased life annuity products
Additionally, only part of the income is taxable. This is because the tax system treats part of the return paid to you as a repayment of the lump sum you invested.
The taxable part of the income from a purchased life annuity is taxed at 20% – this is usually deducted before you get it. Basic-rate taxpayers have no more tax to pay on the annuity income, but higher-rate taxpayers must pay a further 20%.
Non-taxpayers can either have the annuity's taxable part paid gross or reclaim the tax by filling in form R89 from the annuity provider or your tax office. Starting rate taxpayers can reclaim half the tax deducted from their annuity income.
- For a personalised solution, call our experts on the Which? Money Helpline
- Considering your options? Take look at our guide to annuity alternatives
- Read our expert guide to equity release
