A regular income, for life
An Annuity is a series of regular pension payments, usually monthly, up until a specified date or until the end of your life or your spouse. An annuity purchase is usually bought with the payment of 1 premium direct to a life assurance company who offer it. We recommend you seek expert advice when thinking about your retirement options, particularly where you are considering the purchase of an annuity.
How does an annuity purchase work?
You pay the insurance company a single lump sum. In exchange, the insurance company or the annuity provider will then pay you an income each year whilst you are still alive. You could also include the option to have a spouses income to be paid after you die, this would be a % of the income that you receive.
The 2 obvious pros and cons here to consider are the benefit if you live many years whilst retired, this could mean a good return on your investment, whereas if you die early, you may not have realised the full potential of the monies given up in exchange for the regular income.
How is my annuity rate calculated?
There are many factors taken into consideration by annuity providers when they calculate your annuity rate.
- The younger you are the less annual income you receive.
- Women typically receive a lower rate than men because women tend to live longer
- Your lifestyle and health will affect your income
- Medical conditions or unhealthy lifestyles can get more income
Although these personal factors have an impact on your rate, there are also external influences that affect annuity rates generally.
When you pay your lump sum to the annuity provider from your pension pot in exchange for an income, the annuity provider then invests this money to ensure there is enough money to keep paying all of the income that it has promised to pay.
The annuity providers do not make risky investments with your lump sums, as they know they need to pay all the retiree’s income payments. So they tend to have a smaller exposure to stockmarket based investments and more frequently invest in short-term government loans and corporate bonds which pay interest and often have capital protected redemptions.
How are annuities taxed?
The income you receive from your annuities is very similar to a working income, in respect to how it is taxed. Just like regular working staff, the tax on your pension will be deducted through a PAYE (Pay as you earn) system, there is no requirement for a tax return to be submitted to HMRC to pay your tax.
Everyone has a personal allowance and in tax year 2019-2020 you can receive £12,500 in income before being liable to any tax. This allowance applies to any income you receive from an annuity also. Income above this will be taxed in the same way as a regular salary would be.
Do I have to accept the annuity offered by my pension provider?
Not at all and you should never think that this is the best option without looking around for the best annuity purchase! You don’t have to accept the annuity amount offered by your pension provider. You are much more likely to find a much better annuity rate by shopping around and comparing the annuity rates of other providers.
It is crucial that you take the time to compare the best annuity rates when you are coming up to retirement age and not take the first offer. The difference you will receive could be significantly different and provide you with a better income, resulting in a much more comfortable retirement. We would always recommend that you seek professional advice before making this decision.