Annuities

Your pension provider will offer you an annuity. You are under no obligation to take it. The open market option lets you buy from any provider, and the difference between the worst and best rates available at any moment is routinely large enough to matter over a twenty year retirement.

Rates also move. They depend on gilt yields, your age, your health and the shape of income you ask for. A quote is normally only held for a limited period, so timing and paperwork matter more than people expect.

Lifetime annuity

Pays an income for as long as you live, however long that turns out to be. This is the only product that removes the risk of outliving your money. The income is secured by the insurer and, in the unlikely event the insurer fails, annuities are covered by the Financial Services Compensation Scheme.

Fixed term annuity

Pays a set income for an agreed period, often five or ten years, and then usually returns a maturity value you can use to buy another annuity or move into drawdown. It gives certainty for a defined stretch without locking in for life, which suits people who want to see how their health and the rates develop.

Enhanced or impaired life annuity

If you have a medical condition, take regular medication, smoke, or are overweight, you may qualify for a higher income because the insurer expects to pay it for less time. Conditions as ordinary as high blood pressure or raised cholesterol can improve the rate. It is worth completing the health questionnaire honestly and in full. A significant number of people who could qualify never apply.

Investment-linked annuity

The income varies with the performance of an underlying fund, usually with a minimum floor. There is potential for the income to grow, and equally it can fall. These are more complex and suit fewer people.

Every feature you add costs something, because it is paid for by a lower starting income. The choices are what make one quote different from another.

• Single life or joint life. A joint life annuity continues paying a percentage, commonly 50 or 100 per cent, to your spouse or partner after your death. A single life annuity stops when you do.
• Level or escalating. A level income never changes, so its buying power falls every year. An escalating income rises by a fixed percentage or in line with inflation, and starts noticeably lower. Over a long retirement, inflation does more damage than most people allow for.
• Guarantee period. If you die within the guarantee period, commonly five or ten years, payments continue to your estate or beneficiaries for the remainder of it.
• Value protection. Pays out the balance between what you handed over and what you received, if you die early.
• Payment frequency and whether payments are made in advance or arrears.

You can normally take up to 25 per cent of the pot as tax-free cash before buying the annuity, subject to the lump sum allowance of £268,275 unless you hold protection. The income the annuity then pays is taxable as earned income at your marginal rate, and it is usually paid through PAYE with tax deducted at source.

Because the income is fixed, it stacks predictably with your state pension and any other income, which makes tax planning simpler than under drawdown.

A common approach is to use part of the pot to buy an annuity that, alongside the state pension, covers the bills that have to be paid whatever happens. Council tax, energy, food, insurance. The rest stays invested in drawdown for holidays, help for the family and the things that can flex.

That way a poor run in markets affects your discretionary spending rather than your ability to heat the house. It also removes a lot of anxiety, which is not a small consideration.

You can also annuitise in stages rather than all at once, buying additional annuities as you get older. Rates improve with age, so waiting is not necessarily lost ground.

Heritage is a family run firm in Taunton, established in 2000, independent and directly authorised by the Financial Conduct Authority under firm reference 624976. We advise clients throughout Somerset and the South West.

Buying an annuity is close to a one-way door, so it is worth taking the time to get the shape of it right first. We will go through your health, your other income, who else depends on you and what you want the money to do, then research the market before recommending anything.