How to buy an annuity

How to buy an annuity

You can use an annuity to get a guaranteed income for your retirement, but there’s a lot to consider. Here's what you need to know.

lovemoney staff

Investing and pensions

lovemoney staff
Updated on 20 June 2023

Annuity rates soaring ‒ are they worthwhile?

The rates on offer on annuities have risen sharply of late.

Analysis from Hargreaves Lansdown shows that annuity rates have jumped by 20% over the last year, with especially strong increases seen in recent weeks.

According to the investment firm, a 65-year-old with a £100,000 pension would now be able to get up to £7,144 per year from a £100,000 pension, up from £7,027 just two weeks ago.

And we could see even more increases in the months ahead explains Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.

"After being relegated to the sidelines after [pension freedoms], annuities are once again taking centre stage and attracting more notice," she said.

"Recent increases [in annuity rates] are likely in response to the looming Base Rate rise we are expecting this week.

"Interest rates are one factor that determine annuity rates and while it is by no means a certainty, we have seen annuity incomes increase in line with interest rate rises over the past two years.

"With more increases rumoured to be on the way we could see further income boosts in the coming months." 

But just because they are becoming more attractive, that doesn't mean annuities are automatically right for you.

The rest of this guide will take you through how annuities work and how you go about establishing whether you should take one out.

What is an annuity?

When you come to retire, you have the option of buying an annuity with your pension savings.

An annuity is an insurance product, which converts your pot into a regular income that you’ll get for the rest of your life or for a set period of time.

You can purchase an annuity if you have a defined contribution workplace pension or a personal pension.

Annuity rates, which determine what sort of income you get from your pension pot, have been in the doldrums for a decade, but as we have seen have been on a resurgence over the last 18 months.

And, as mentioned earlier, with Base Rate having been hiked repeatedly ‒ and further increases looking likely ‒ this should help to drive up annuity rates further.

Want to know how much income you'd get from an annuity? Use this calculator from Key to find out

Does anyone want an annuity anymore?

The popularity of annuities took a hit with the introduction of pension freedoms. 

There are alternatives to buying an annuity, including income drawdown where your pot remains invested, or either withdrawing a lump sum or smaller cash sums.

If you’re considering buying an annuity, read on to find out what you need to know.

Everything you need to know about pensions

Get a benchmark quote

Around six months before you retire, your pension provider (or providers depending on how many funds you have) will send you a pack.

This should tell you how much you have in your pot, the different types of annuities available and the benefits of shopping around.

It will also contain a personal information form, which you can submit to get an annuity quote.

A follow-up pack will be sent around 10 weeks before you retire and will outline your personalised quote based on the information you have given.

But you don’t have to stick with the provider that has invested your pension.

You have the right to buy your annuity from any provider, regardless of who your pot is with. And you can potentially get more money by shopping around for a better deal.

According to the Financial Conduct Authority, eight out of 10 people lose out by not switching annuity providers, so don’t be tempted to take the easy route and stay put.

Instead, use the quote from your existing provider as a benchmark and aim to beat it, unless they provide a Guaranteed Annuity Rate (GAR) in which case you might want to stay put as these tend to offer a better deal than the rest of the market.

Want more information about annuities? Key may able to help

Find the perfect annuity fit

Before you begin to shop around, you should figure out what sort of annuity to look for.

Annuities come in all sorts of shapes and sizes. Choosing the right annuity depends on your own personal circumstances, financial priorities and your attitude to risk.

Things like whether you are married or have a partner, your health and lifestyle, and whether you are worried about your annuity income losing value are likely to impact your decision.

Here are some common annuity products that you might want to get quotes for:

Single-life annuity

A single-life annuity will provide you with a fixed regular payment until you die and often offers the highest starting income figure.

But it has downsides. For example, your fixed income may lose value over time due to inflation.

Also, after you die, the payments will stop – so if you have a partner or dependents, they won't get anything.

Joint-life annuity

With a joint-life annuity, some or all of your income is paid to your partner or dependants after you die. The payments continue until they die or have reached a specific age.

Due to this guarantee, the income pay-out is less than what you would receive on a single-life annuity.

Guaranteed period annuity

A guaranteed period annuity only pays an income for a certain time, in most cases up to 10 years.

If you die during the guarantee period, income is paid to your dependants or can be converted into a lump sum and inherited along with the rest of your estate.

It’s an inexpensive option but offers weaker protection for any dependants compared to a joint-life annuity.

Escalating annuity

You can protect the income you receive from being eroded by inflation with an annuity that is linked to the Retail Prices Index (RPI) or that increases by a fixed percentage each year.

But this is likely to mean your income starts at a lower amount before increasing over time and some providers will only allow your income to go up by a certain amount – even if inflation is higher.

Investment-linked annuity

As well as fixed and increasing payments, you could choose an annuity that varies according to the performance of investments.

When your investments do well, your pension income is boosted, but when they do badly, your income will sink.

Enhanced annuity

An unhealthy lifestyle or medical conditions such as cancer can boost your income thanks to an enhanced annuity.

That’s because these factors can reduce your life expectancy, meaning your pension fund doesn't have to stretch so far. So, in some cases, income can a lot higher compared to a regular annuity.

Want to know how much income you'd get from an annuity? Use this calculator from Key to find out

Shop around for the best rate

You should do your research to get an idea of what annuity rate you could expect based on your circumstances.

When you get a quote for an annuity, you'll be given a rate as a percentage. You'll need to multiply this by your pension savings to calculate how much income you'll get every year.

So, if you have £100,000 in your pension pot, and are offered an annuity rate of 5%, you'll get an annual income of £5,000 a year.

Annuity rates depend on several factors, including your age, life expectancy, gender, health, the economy, how big your pot is and the type of annuity extras you choose.

You might have other pension funds kicking about that you could combine to make one big fund to help buy a better annuity.

These might be with employers you used to work for but have left. You can use the Pension Tracing Service to find pots you have lost track of over the years.

Pension tracing: how to find your old pension pots

Getting advice

In most cases, buying an annuity is a one-off and irreversible decision, so choosing the right type and getting the best deal are crucial.

Since there's no going back, you might want to do your own research, but also seek out some advice.

There are two types of advice you could go for: financial advice or information and support.

With financial advice, an advisor can assess your situation, explain your options and recommend a product. This can cost several hundred pounds, and you will have to pay more if you want help with the paperwork.

If you have a smaller fund (under £50,000), you might be better off going to a specialist annuity broker for information.

Brokers can find the best deals on the market but won't recommend a product, so they give information rather than advice. Costs are built into the annuity rates quoted.

Once you’ve chosen your annuity, your pension savings provider will transfer the funds and your annuity should be set up within 30 days.

If you want to learn more about annuities, or retirement planning in general, take a look at this comprehensive guide to pensions.

Pension advice: when you need it, where to get it and how much it will cost

*This article contains affiliate links, which means we may receive a commission on any sales of products or services we write about. This article was written completely independently.

Is there a ‘best’ time to get an annuity?

This isn’t an easy question to answer, since the circumstances of individual retirees can vary significantly. But analysis from LCP has highlighted that the attractiveness of an annuity grows with age, so that it becomes a better value option as you get older.

It noted that the idea of keeping a hands-on approach to your pension management as you get older is less appealing ‒ realistically you might not be in the best position to do so as you enter your later years. 

Similarly there can be concerns over the chances of running out of cash entirely if you end up living for longer than expected. By comparison, cashing in your pot for an annuity removes that uncertainty, since you enjoy that income for life.

An added selling point is that as you get older, the chances of developing some form of ailment ‒ and therefore qualifying for an enhanced annuity ‒ also increase.

Thinking of freeing tax-free cash from your home? Use the Fluent Money equity release calculator below to see how much you could get.

*This article contains affiliate links, which means we may receive a commission on any sales of products or services we write about. This article was written completely independently.

Most Recent