Q&A: What is an annuity?
We clear up some of the confusion over pensions and annuities.
According to research from Sun Life Financial of Canada, 42 per cent of people in the UK do not know what an annuity is.
Even those over the age of 55 who may soon need to purchase an annuity seem confused. While 23 per cent incorrectly described an annuity, a further 23 per cent had no idea what the term meant.
With a report from MGM Advantage claiming a typical couple needs £564,227 to support themselves in retirement, we answer some of the most common questions on annuities.
1. What is an annuity?
An annuity is an insurance policy that gives people an income in exchange for a lump sum – usually from their pension fund.
Once you buy an annuity, you hand over all (or part) of your pension fund to the insurance company. The insurer provides you with regular payments for the remainder of your life.
It is possible to take 25 per cent of your total pension fund as a tax free lump sum before you buy your annuity.
You can buy an annuity between the ages of 55 and 75.
2. Are all annuities the same?
No, there are many kinds of annuities. Here are some of the most common.
- Level: pays a fixed amount every year.
- Escalating: allows you to increase the amount of your payments – in line with prices or a rate agreed when you purchase the annuity.
- Guaranteed period: pays out for a fixed number of years even if you pass away.
- Impaired life: those with lower life expectancy due to serious health problems get more favourable rates.
- Unit-linked: the amount of income fluctuates to reflect the value of your investment fund – ie your pension pot.
- Enhanced annuity: more favourable rates to heavy smokers or those who are overweight.
With all the available types, buying your policy can seem a bit of a gamble. An independent financial adviser should be able to discuss the options with you.
3. Do I have to buy one?
Under current regulations, savers are required to purchase an annuity before the age of 75. However, the situation may soon change.
The Liberal Democrats and the Tories have pledged to end this obligation if they come to power after the election. Both parties argue that forcing people to buy an annuity robs them of financial control.
4. Can I change my mind after I have bought my annuity?
Buying an annuity is a decision for life. Once you have purchased the policy, you cannot switch to another company or alter the terms of your agreement.
Those who purchase their annuity without taking financial advice are taking a serious risk with their financial future.
5. What is the position with tax?
The amount of tax you pay on your annuity will be determined by your age and overall income.
Once HM Revenue & Customs has worked out how much tax you need to pay, it will send your tax code to your annuity provider and the company will deduct this amount from the money it pays you.
**This material is for information purposes only and should not be considered financial advice. We strongly encourage our readers not to rely solely on this content, but to seek independent advice when making financial decisions.**
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