How to buy an annuity

Updated on 11 February 2019

We look at how to get the most from your retirement pot.

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.

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

There are alternatives to buying an annuity. These include income drawdown where your pot remains invested, phased retirement where your pension pot is split into segments and trivial commutation where your entire pot is taken as cash.

But an annuity is the most common method of arranging retirement income, with around 400,000 people choosing to go down this route each year.

So let’s take a look at how to buy one.

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 which will 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 ten weeks before you retire and will outline your personalised quote based on the information you have submitted.

But you don’t have to stick with provider that has invested your pension. You have the right, under the open market option (OMO), to buy your annuity from any provider, regardless of who your pot is with. And you can get up to 30% more by shopping around for a better deal.

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 your provider offers 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.

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, your financial priorities and your attitude to risk. Things like whether you are married or have a partner, your health and lifestyle conditions, 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 lifetime annuity

A single-life annuity will provide you with a fixed regular payment until you die and often provides the highest starting income figure. But it has downsides. Because of inflation your fixed income will lose value over time. Also after you die the payments will stop so if you have a partner or dependents they won't get anything.

Joint-life lifetime 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 specified age. Because of this guarantee the income pay-out is less than what you would receive on a single-life annuity.

Guaranteed annuity

A guaranteed annuity only pays an income for a certain time, in most cases up to ten 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 your 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 or that increases by a fixed percentage each year. But this is likely to mean your income starts lower before increasing over time. However those increases may not actually be enough to make up for the initial shortfall, as we explain in Why a flat annuity beats an inflation-linked annuity.

Investment-linked annuity

As well as fixed and increasing payments you could choose an annuity which 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 like 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 be 40% higher than with a regular annuity.

Shop around for the best rate

You can use to get an idea of annuity rates 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 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 a number of factors including your age, your life expectancy, your sex, your 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.

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 around £750 but you will have to pay more if you want help with the paperwork. You can find an advisor using the Association of Professional Financial Advisors or the Personal Finance Society.

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


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