What is an annuity?

An annuity is an insurance product that will provide an income in retirement in exchange for a lump sum. This lump sum would typically have been built up over time by contributing to a pension product.

An annuity provider will calculate how long you are likely to live in retirement and set the income accordingly. If you live to a good age you will benefit from the continued income if, however, you die before your expected age then you lose out.

Prior to April 2015 buying an annuity was the only available course of action for anybody owning a defined benefit pension when they retired. In April 2015 the rules were changed to give individuals greater access to their pensions from the age of 55 which resulted in a decrease in the number of annuities purchased.

An annuity provides a guaranteed income in exchange for a lump-sum payment. The amount of income provided will depend on an annuity provider's assessment of your life expectancy and the type of annuity purchased.

If you are using a pension pot to buy an annuity then you can withdraw 25% of your pension pot tax-free before you purchase the annuity. The income from an annuity is liable to income tax and this tax will be deducted at source, so you will receive the net amount.

Pros and cons of an annuity

Pros

• Conventional annuity pays you an income which cannot go down in value

• Income is paid until you die – not for a limited period

• Income will never run out in your lifetime.

• There’s no investment risk for conventional annuities

• It can provide an income after your death to other family members

• You can protect your income against inflation

Cons

• Once an annuity is set up you cannot change it

• Conventional annuity is set up on your life only, on your death it will stop

• You must decide what income type you require at the outset

• You must decide what additional benefits you are going to include from outset

• Conventional annuity enjoys no further benefit from investment growth

• Annuity rates fluctuate over time, therefore, if you buy when the rate is low your income is fixed at this rate