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What is an annuity and how do annuities work?
Many people are looking for reliable ways of funding their retirement. Perhaps you’re planning trips you put off because life kept getting in the way or have a hobby you’d like to devote more time to. Or maybe you just want to make sure the bills are covered for the rest of your life.
An annuity is a way of turning your pension savings into a guaranteed income that usually lasts for the rest of your life. It can be a very reliable way of funding some or all of your retirement. That’s why you could say that the real meaning of an annuity is security.
What’s the actual definition of an annuity?
An annuity is a financial product that gives you a regular, guaranteed income when you retire. You’ll get monthly, quarterly or annual payments. They can last for the rest of your life or for a fixed period.
That makes annuities a very low risk way of funding your retirement and help you with your planning and budgeting. That’s why we often talk about annuities really meaning security.
- People usually buy annuities with money from their pension pot.
- You can only buy one when you’re 55 or older, or 57+ from 6 April 2028.
- Once you’ve set one up you can’t make any changes to it.
What sort of annuities can I choose from?
The most common type of annuity is a lifetime annuity. It regularly pays out a guaranteed sum of money for the rest of your life. If that doesn’t meet your needs, other types of annuity include:
- Joint lifetime annuities, which regularly pay out a guaranteed sum of money for the rest of your life, then keep paying it to a loved one after you die.
- Fixed term annuities, which pay out a guaranteed sum of money for a fixed period of time, stopping when that time ends. You can also choose a lump sum payment at the end of it.
- Enhanced annuities, which give you a better annuity rate if you have certain health or lifestyle issues.
How do annuities work?
An annuity usually pays you a regular monthly, quarterly or annual income for the rest of your life, no matter how long you live. You can also choose a temporary annuity (or fixed-term annuity) which only pays out for a set period. Both types can keep paying out to a loved one if you die before them.
The amount of income you can get will depend on:
- how much you choose to spend when you set it up
- what choices you make when you set it up
- the annuity rate your provider offers you
- health and lifestyle factors
You set the income amount when you buy your annuity.
Calculating your annuity
- You can use our Annuity Calculator to find out what your potential income could be based on the amount you have to spend.
- We can create a personalised annuity quote for you, which will also tell you if you could get a better rate elsewhere. We want you to find the right annuity for you.
What are your annuity options?
When you’re choosing and setting up your annuity, you’ll probably have different options to choose from. In particular, you’ll have to decide whether you want your annuity payments to:
- Last for the rest of your life or for a fixed period only
- Fixed term products usually last for between three and 25 years
- Some fixed term products also pay out a lump sum when they end
- Rise over the life of your annuity
- This will help your income keep up with inflation
- Bear in mind that your starting rate will be lower
- Look after a loved one after you die
- Keep paying them for a fixed period or the rest of their life
- Pay them a one-off lump sum
Is an annuity income taxable?
Yes – your annuity income is treated like any other taxable income, including your State Pension. If your total income, including the money you receive from your annuity, goes above your personal allowance, it’s taxable.
The exact amount of tax you pay will depend on your personal circumstances – it may change if your income tax rate changes. Whether or not you’re working will also make a difference. Once you stop receiving a salary and begin relying on your retirement income, you could find that you’re in a lower tax bracket. Your annuity income can still affect any means-tested benefits you might receive.
If you die and your annuity income starts going to a loved one, they’ll have to pay income tax on it and it could affect their benefits too. But the annuity income won’t incur any inheritance tax.
What happens to an annuity when you die?
Usually, when you die your payments will end. But you’ll probably have other options if you want to make sure a loved one is taken care of. These can include:
- Having some or all of your income paid to a loved one. That can continue either for a set period of time or until they reach the end of their own life.
- Protecting a percentage of the money you use to buy your annuity – for example, 25%, 50% or 100% of it. Your provider will pay out a lump sum based on that amount.
Their exact details will depend on the provider you choose. They’ll probably cover the costs of any after-death benefits by offering you a lower annuity rate. But remember that if you live longer than average, the payments you receive are likely to add up to more than you paid to buy the annuity. But if you die earlier than expected, you might get back less than you spent on it.