How to choose an annuity

Fact Checked
If you want guaranteed income when you retire, you can use all or part of your pension to buy an annuity. Here we explain how to choose the right one for you.
Share this guide
Older lady at kitchen table drinking tea

Pensions are long term investments. You may get back less than you originally paid in because your capital is not guaranteed and charges may apply.

Annuities can provide peace of mind that you will always have money to pay the bills. However, they aren’t reversible so it’s important to do your research and choose the best arrangement for you.

Make the most of your tax-free ISA.

What are annuities and how do they work?

Annuities are insurance policies; in return for all or part of your pension fund they pay you a regular income until you die. Once you die, payments stop unless you have paid extra for a joint policy that will carry on making payments to your spouse or partner, or guarantees that ensure payments are made for a fixed number of years.

You can choose from a number of different income options: 

  • Level income: This gives you a set income for life.

  • Escalating income: This increases your annuity income each year by a set percentage you choose.

  • Inflation-linked income: This gives you an income that increases in line with the rate of inflation each year.

Escalating and inflation-linked annuities pay a lower level of income initially, but rise over time to help you cope with rising costs of living. 

You can usually choose to have your income paid:

  • Monthly

  • Quarterly

  • Half yearly

  • Yearly

You can start taking your income from the date you buy your annuity, the next payment date after opening your annuity, or at a date of your choosing.

Why should I buy an annuity?

Annuities offer something that few other retirement income products can: guaranteed income for life. It gives you the confidence that your money won’t run out, spares you the hassle of managing an investment portfolio and means you don’t need to panic if there’s a stock market crash.

If you are married or have a partner, a joint policy also means you can be confident that they will still have an income if you die first. 

Do annuities provide value for money?

There’s no escaping the fact that annuity rates are low, and you may be disappointed with the income you get. This means it’s absolutely vital you don’t accept the first annuity offered to you by your pension provider and shop around for the best possible rate. You should also look at other products, such as income drawdown, to see if that would work for you better.

Ultimately how much value for money you get depends how long you live. The income you receive will be based on life expectancy and if you live longer than anticipated you could receive more in income than you spent buying your annuity. 

However, the opposite is also true. If you die shortly after taking out the plan you may get less back than you paid in.

Can I protect my annuity?

Many annuity buyers will, understandably, worry about dying shortly after they have taken the policy out and not getting their money back.

Thankfully there are some steps you can take to protect your investment, however they will reduce the level of income you get at the outset.

Guarantees, for example, ensure that payments are made for a fixed period of time. This is typically five to 10 years but can stretch as long as 30 years.

Alternatively, you can select value protection which returns all or a portion of your unspent funds when you die.

Can I get a higher income if I have health problems?

Enhanced annuities pay a higher level of income to people who smoke or have health problems. This is because the insurance company expects you to have a shorter life expectancy. You don’t have to be seriously ill to benefit; smoking, diabetes, high blood pressure or cholesterol could all make you eligible for a higher income.

When should you buy an annuity?

The youngest you can buy an annuity is age 55. However, it’s unlikely you’ll need to buy an annuity until you finish work and need to replace your earnings with income from your pension.

As a guide, the longer you can hold off buying an annuity the better. This is because the older you are, the shorter the period it will need to pay out, so the higher the income you’ll get.

What if you change your mind?

Annuities will generally have an initial 30-day cooling-off period in which you can change your mind. However, after that point they are not reversible. This is why it is so important to think carefully about whether an annuity is the best option for you and to make sure you choose the right type of policy.

If you aren’t sure, it’s worth talking to an independent financial adviser.

Is it possible to get a temporary annuity?

Most annuities are lifetime policies, meaning they guarantee to pay you an income for the rest of your life. However, if you don’t feel ready to commit to a lifetime policy, some insurance companies do offer fixed-term annuities. These can be set over periods from one to 40 years, however between five and 10 years is typical.

Once the policy ends you will receive a ‘maturity value’ (typically your investment less income paid out and charges) which you can then use to buy another annuity or use in another way.

What are the alternatives to annuities?

Buying an annuity is not your only option when you retire. There are a number of ways to generate an income from your pension and you can also mix and match, using any combination of the following: 

  • Buying an annuity

  • Converting your pension to income drawdown (leaving it invested)

  • Taking part or all of it as cash and leaving the rest invested

  • Taking a series of lump sum payments

Here is more information on your options when withdrawing from your pension.

You can help ensure you have the retirement you want by finding the best personal pension plan to make your money work as hard as it can.