The most basic type of annuity – called level or standard annuities – involve a simple insurance deal to receive a fixed amount each year. You buy the annuity with your pension savings, and this is turned into a guaranteed monthly income for the rest of your life.
You don’t have to use all your pension savings to buy your annuity: you can use part of your fund to generate an income, while leaving the rest invested in the stock market, for example, so you can take advantage of any further growth.
Some annuities will increase year on year so as inflation makes your day- to- day purchases more expensive, your income rises to cope with this. While there is an obvious advantage to this, these inflation-linked annuities are more expensive – so the money you receive each year starts from a lower sum than if you simply take a fixed amount until death.
There are also annuities which invest in stock markets and offer you incomes dependent on how these investments pan out. These are known as investment- linked annuities. Needless to say these are riskier than normal annuities and should not be entered into without financial advice.
One type of annuity that is worth considering, if you are eligible for it, is an enhanced or impaired annuity. This is where factors lead the insurer to expect you to live less long than the average person, and in return pay you a higher income..
Higher income with an enhanced annuity
Most normal annuities will already take into account the average life expectancy of the postcode area in which you live, but enhanced ones will take into account whether or not you smoke, how much you drink, your family medical history, as well as requiring a detailed check of your own medical circumstances.
An enhanced annuity is the opposite of a life insurance policy in that poor health and unhealthy lifestyles count in the policy holders favour. This seems morbid to many people but can dramatically increase the amount of money you and your family have for retirement.
If you have a partner who is relying on your pension when you retire, consider a joint-life annuity. These are like normal annuities, except that the income you receive continues to be paid to your spouse or partner (and in some circumstances children), after you die.
Most typically your spouse or partner will receive some or all of the annuity income until their death, but insurers may also continue paying out to children for a limited period (often until they are 18).
Not surprisingly the potential disadvantage to these are that they cost more than normal (or ‘single life’) annuities, so the sum you start off receiving from retirement is smaller with a joint annuity.
Other things to consider are that the more of the annual income you want your partner or children to receive and the longer you want them to get it, the less the annuity will generate when you take it out.
Find out more about annuities