Your options when you retire
If you have a defined contribution pension, you have several choices when you reach retirement age, currently 55 (57 from 2028).
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 a variety of annuities to choose from. Depending on your circumstances you may prefer one over another.
A lifetime annuity (sometimes referred to as a ‘single life’ annuity) guarantees to pay you a regular income between taking one out and when you die. A lifetime annuity means you’ll know precisely how much income will be paid out to you each month. However, if you die before your annuity has been fully paid out to you, the remaining amount in your annuity may not necessarily go to your beneficiaries, so, you’ll need to ensure you understand the conditions of a lifetime annuity before you take one out. If you purchase a lifetime annuity you won’t be able to reverse your decision. You won’t be able to move the money you put into a lifetime annuity out of it.
Temporary annuities (also known as fixed-term), as the name implies, will pay out a regular income over an agreed period of time. The length of term available varies but typically ranges between one and 40 years. They differ from lifetime annuities in a couple of different ways. Firstly, when your fixed term has finished you’ll be free to look at alternative options and if you die before your term, any remaining funds will usually be able to be paid to a beneficiary.
An enhanced annuity may be suitable if you have a health-related issue which could reduce your life expectancy. This type of annuity typically pays out more than other types of annuity so you may receive a higher income. You’ll usually be required to answer questions about your health and may even need to provide supporting information from your doctor. This information’s used to estimate your life expectancy and your annuity rate.
In an investment-linked annuity, your retirement income’s invested, for example, in company shares or bonds, so the amount of income you receive may vary in line with how your investment’s performing in the market.
With an escalating annuity, the amount of retirement income you receive will go up each year for life at an agreed fixed percentage or it may rise in line with 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 annuity rates you’ll be offered.
You’re also likely to be offered higher annuity 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, use an annuity calculator, 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.
You may also want to consider whether a guaranteed annuity rate (GAR)’s offered as part of a pension scheme. If this is an option, the pension provider will guarantee to pay a particular rate on your annuity if you also take an annuity out with them.
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: 16-02-2023