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Choosing an annuity
This information applies to England, Wales, Scotland and Northern Ireland
About choosing an annuity
This page has information for people who are in a money purchase pension scheme.
You will be in a money purchase pension scheme if:
- you've arranged your own personal or stakeholder pension, or
- you're in a workplace stakeholder pension scheme or group personal pension scheme (also known as defined contribution schemes).
For more information about personal and stakeholder pensions which you arrange yourself, see Personal pensions.
For more information about workplace pension schemes, see Workplace pensions.
If you have one of these types of pension, you may think that when you retire, the pension provider will start paying you a regular pension. But this is not quite right. You will need to take the money you have saved up in your pension fund and use it to buy an annuity. This is a financial product which guarantees to provide you with an income for your retirement.
If you want, you can take up to 25% of the money in your pension fund as a tax free lump sum anduse the rest to buy anannuity.You can use the lump sum for whatever you want, but you will not have as much money to buy an annuity, so your pension income could be lower. It's best to seek financial advice if you are unsure about whether to take a lump sum.
You will need to be able to make some choices about the type of annuity you want to buy. You could just choose to buy the annuity which your pension provider will offer you, but you don't have to. There are lots of different types of annuity on the market and you may find one which offers you a higher rate of income and is better for your personal circumstances.
It's important to spend a lot of time choosing the right kind of annuity for you because, once you've bought it, you can't change your mind and switch to another one.
On this page, you can find information to help you understand how annuities work, when you need to buy one, where to find a provider and what options you have for choosing an annuity.
Although most people with a money purchase pension choose to buy an annuity, there are some other options available for getting a retirement income. Our section on Other ways to receive your pension tells you more about these.
You can find details of more information about pensions and other financial information on Adviceguide under Further help and information.
Who needs an annuity
You'll need to think about buying an annuity if you've arranged your own personal or stakeholder pension.
If you're in a workplace money purchase or stakeholder pension scheme, the pension trustees or provider may make this decision for you. But you do have the right to choose your own annuity from another provider and you could get a better rate. Don't be afraid to ask them what steps they've taken to get the best deal.
If you're not sure whether you have a money purchase pension, check your paperwork, speak to your provider or get advice.
You can get help to look at your pension paperwork from your local Citizens Advice Bureau. To search for details of your nearest CAB, including those that can give advice by e-mail, click on nearest CAB.
How annuities work
When you buy an annuity you swap the money in your pension fund for a regular income. This will be your pension.
You will get a regular income worked out annually. This can be a set amount or vary, depending on the type of annuity you choose. The most straightforward annuities are called lifetime annuities and guarantee to pay you an income until you die. You can add on various options to lifetime annuities to suit your particular needs.
Choosing a provider
Insurance companies and other financial providers sell annuities and other retirement options. There are lots of different products so shop around to compare what's on offer before you choose.
You can buy your annuity from the company who you took out your pension fund with. However, you don't have to buy it from them. You have a legal right, under something called the open market option (OMO), to buy your pension annuity from any provider, regardless of who your pension is with. So always check what your pension provider is offering and compare it with other providers in case you can get a better deal elsewhere.
Your pension provider should send you information about the things you'll need to think about, around four to six months before your retirement date so that you can start to prepare. This includes an estimate of the value of your pension fund and how much retirement income you can expect to get if you decide to buy a lifetime annuity with them.
Working out your financial priorities
To help you decide what type of annuity to choose, it's best to first think about what your priorities are and what needs you'll have after you retire. Some of the things to think about include:
- whether you want an income just for you, or for anyone else
- whether anyone else who is financially dependent on you may need an income if you die first
- whether you are in good health, and how long you might live
- whether you have enough income from other sources such as savings or a part-time job to delay starting your pension
- how flexible you want the pension to be, for example, if you want to increase your income as you get older
- whether you would like to carry on investing in your pension fund after you retire
- whether you want to provide an inheritance for someone.
You can use the annuities comparison tool on the Money Advice Service website to help you choose. Go to www.moneyadviceservice.org.uk.
How much income you'll get from your annuity
The amount of income you’ll get from your annuity depends on the type of annuity you choose and the annuity rate you're offered. The rate you get for your annuity is set when you take it out. The rate won’t go down after you’ve taken it out. However, if general annuity rates go up in the future, the rate you are getting will not increase.
Annuity rates
The annuity rate is the rate at which your money is paid over to you from your fund. What annuity rate you'll be offered is affected by the following things:
- your age. If you retire earlier, your pension will need to pay out for longer and so you'll get less income each year
- your life expectancy. This is based on what happens in the population as a whole. An annuity insures you against living longer than average
- your sex. Women are expected to live longer than men. This means your pension fund needs to last longer so you'll get less each year. This isn't classed as discrimination
- your health. You may be offered a higher yearly income than someone else if you're in poor health or not expected to live long. This is one of the occasions when poor health or your lifestyle, for example if you smoke, can benefit you
- the economy. Annuity rates are affected by general interest rates and can go up and down like any other investment
- how much money you have to put into your annuity. Some providers offer better rates for people who can invest large amounts and others only accept sums over a certain amount
- the type of annuity and any extras you choose, for example guarantees, survivor pensions or index linked.
The provider will look at your individual circumstances and offer you a rate based on them. Different providers may offer you different rates so get quotes from a number of providers to see who offers the best deal.
If you've got more than one pension fund, think about combining them when you're shopping around. You may get a better annuity rate from a larger fund. If you have a few small pension funds, putting them into one pot can also help you to reach the minimum amount some providers ask for before they'll sell you an annuity.
An independent financial adviser can give you advice about combining your pension funds and help you to find the best options for your situation.
For more information about where to get independent financial advice, see Getting financial advice.
Types of annuity
Once you've bought an annuity, you can't switch to another one, so it's best to look at all your options very carefully before deciding on which one is right for you.
Most people choose to buy a lifetime annuity. These are annuities which guarantee to give you an income for the rest of your life. There are several different types of lifetime annuity and you will need to work out which type best suits your needs. The main questions you will need to ask yourself are:
- do you need a pension just for yourself or for a partner as well?
- how do you want to get your income?
- are you in good health and how long are you likely to live?
Do you need a pension just for yourself or for a partner as well?
If you're just buying a pension for yourself, you can choose a single lifetime annuity.
If you want a partner, husband, wife or civil partner to carry on getting an income after you die, you can choose a joint lifetime annuity.
A joint lifetime annuity, also called a survivors pension, pays some or all of the income from your annuity to a partner, when you die. This type of annuity can be particularly useful where your partner doesn't have a pension of their own. However, if they are more than ten years younger than you, you may find it harder to get a joint annuity.
How much you get will be affected by your partner's age and how much income you want to leave them. If you want to leave your partner a higher percentage of pension income after you die, the income you receive at the start of your pension will be less.
However, some annuities will pay out no more than half income to your surviving partner, husband, wife or civil partner. If you want them to receive more, you'll need to choose an annuity that allows a higher percentage to be paid out.
You'll usually get a lower income than with a single life annuity, if you choose this type of annuity because the provider will expect the pension pot to last longer.
If you have a partner and are not married or in a civil partnership, you should check with your pension provider whether your surviving partner will be allowed to receive a pension if you die first.
Pensions can also be paid to other dependents after your death, such as children, although payments may stop when they reach a certain age.
How do you want to get your income?
Once you've worked out whether you want a joint or single lifetime annuity, you will need to work out how you want to get your income.
You can choose to get an annuity which will pay you a set amount of income for the rest of your life, so what you get at the start will be the same as you get years later. This is called a level annuity.
Alternatively, you can choose an annuity which gives you a bigger amount of income each year. This is called an increasing annuity.
Both level and increasing annuities can either be single or joint lifetime annuities.
A level annuity is a good choice if you want a better income to start with, for example when you're younger and healthier. But the spending power of your money may be affected by rises in the costs of living later on because your money won't go up. You may end up with little money to live on if you expect to live a long life.
An increasing annuity is a good choice if you're worried about how you will manage financially with future rises in the cost of living (inflation). An increasing annuity protects you against inflation. This means you'll start off with a smaller annual income than you would get if you had taken out a level annuity, but it will go up each year. This can give you the same buying power throughout your retirement.
With an increasing annuity, it can take a long time for your income to catch up with what you would have got if you'd chosen a level annuity rate at the start of your retirement. So it may be worth thinking about if you expect to live a long life and are in good health.
Annuities for people in poor health
If you have an existing health condition, you might want to think about buying an enhanced life annuity or impaired life annuity. These annuities offer higher rates of income to people with certain health conditions such as a history of heart disease or cancer. You can also get this type of annuity if you are considered a higher risk because of your lifestyle, for example if you're a heavy smoker.
The provider pays you a higher rate because they don't expect you to live that long.
You can get single or joint enhanced and impaired life annuities, depending on whether you want the pension to pay for a partner after you die.
You can also get level or increasing enhanced and impaired life annuities.
Investment-linked annuities
There are annuities which allow you to keep your pension fund invested in the stockmarket while you take an income. These are called investment-linked annuities. The income you get from an investment linked annuity may rise and fall according to how well the investments are doing and whether you receive any bonuses.
There are two types of investment linked annuity:
- a with-profits annuity
- a unit-linked annuity.
Because the money from these annuities is still invested in the stockmarket, there is a risk that your income may fall if the investments do badly. These types of annuity are therefore really only suitable for people who:
- have a very large pension fund of at least six figures
- are willing to take a risk that their investments could lose money
- have income from other sources such as savings and investments.
If you are thinking about buying an investment linked annuity, you should get independent specialist financial advice.
For more information about getting independent specialist advice, see Getting financial advice.
Guaranteed annuities
Guaranteed annuities are annuities which only pay out for a certain amount of time, for example five or ten years. They will pay out whether or not you die during that time. If you do die during the guaranteed period, the payments you would have got can either carry on being made to your survivors or can be rolled into a lump sum and inherited along with the rest of your estate.
If you're thinking about this as a way to provide for a partner, make sure you compare the benefits with joint lifetime annuity products which may offer you more in the long term. Remember, a guaranteed annuity will only pay out for a specific length of time.
You might also want to think about buying a guaranteed annuity if you want to keep some of your pension fund invested in the stockmarket but have a guaranteed income at the same time.
For more information about investing your pension fund while taking a retirement income, see Pensions - income withdrawal.
If you want to leave your pension in your will
If you want to leave your pension in your will, you need to choose a certain type of investment called a value protected annuity or capital protected annuity. If you die before the age of 75, the money left in your pension fund can be inherited along with the rest of your estate. But an amount for tax will be taken off first.
Tax-free lump sum
You can take up to 25% of your pension fund as tax-free cash, but you have to do this before you’re 77. Bear in mind though, that this reduces the amount of pension income you can get from your pension fund.
Other ways to receive your pension
Most people with a money purchase pension choose to buy a lifetime annuity when they retire. However, you do have some other options.
You don't have to buy an annuity straight away when you retire. In some circumstances you may decide to put off buying an annuity, perhaps because you want to carry on working or have an income from somewhere else.
If you decide not to buy an annuity now, you could choose to take money directly from your pension fund while leaving some of it invested. This is called income drawdown or income withdrawal.
Remember, you can't change your mind once you've bought an annuity so it's best to look at all the options before making a decision.
You should get advice from an independent financial adviser before making a final decision about how to invest your pension fund.
For more information about where to find an independent financial adviser, see Getting financial advice.
For more information about income withdrawal, see Pensions - income withdrawal.
Further help and information
On Adviceguide
For more information about pensions, including different types of pension and what to do when you're nearing retirement, see Pensions.
You may also find the following Adviceguide information helpful:
The Money Advice Service
The Money Advice Service is a free, independent service. Their website has lots of useful information about pensions including an annuities comparison tool to help you choose an annuity. There's also a range of leaflets to help answer your pensions and retirement questions.
Go to: www.moneyadviceservice.org.uk.
The Pensions Advisory Service (TPAS)
TPAS is an independent organisation that provides free information, advice and guidance about all types of pensions including state retirement pension, company, personal and stakeholder schemes.
Go to: www.pensionsadvisoryservice.org.uk.
The TPAS annuity planner gives you general information and guidance to help you with the decision-making process for converting your pension fund into income.
Go to: www.pensionsadvisoryservice.org.uk.
