What is a pension annuity?

A pension annuity is a financial product that pays you a guaranteed income for a fixed period or for the rest of your life. When you retire, you can choose to use some or all of your pension savings to buy an annuity.

Your options when you retire

If you have a defined contribution pension, you have several choices when you reach retirement.

You can take up to 25% of your pension pot as a lump sum without paying tax. If you take out more than this you’ll have to pay income tax.

You can then leave the rest of your money invested and dip into it when you need it via drawdown, or you can buy a pension annuity. An annuity guarantees that you receive a regular income during your retirement.

For example, you have a pension pot of £133,333 and you retire at 65. You take 25% of your pot as a tax-free lump sum and you decide to buy an annuity with the remaining £100,000. You use the money to buy an annuity that guarantees an annual income of £4,500 for the rest of your life.

Different types of pension annuity

There are lots of different things to consider when you’re choosing a pension annuity.

For example, you can choose between a lifetime annuity for a guaranteed income until you die, or a temporary annuity, guaranteeing an income for an agreed period.

If your life expectancy is quite low - perhaps because you have an unhealthy lifestyle or you’ve suffered from ill health - you may be eligible for an enhanced annuity, which usually means receiving a higher income.

Then there’s the option to buy an annuity that’s investment linked if you’re willing to take some risk, and the decision on whether or not you want an escalating annuity, which goes up each year based on a fixed percentage or linked to inflation.

Buying a pension annuity

As well as the type of annuity you choose, the annuity income you get can depend on things like your age, health and where you live. Generally, the older you are, the higher the income rates you’ll be offered.

You’re also likely to be offered higher rates if you have a shorter life expectancy for other reasons, for example you’re in poor health or you’re a smoker.

It’s important to know that you don’t have to buy your pension annuity from the company that’s been managing your pension plan: it’s a good idea to compare annuities from several providers to find the one that suits you best.

You can compare pension annuity rates online, or speak to a financial adviser if you’re not sure what to do, in particular if you’ve got a high-value pension pot or you’re looking at more complex annuity options.

PensionBee has partnered with Legal & General to offer a pension annuity to anyone who would prefer a different option to our drawdown service.

Risk warning

As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.

Last edited: 12-08-2021

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