What are annuities?
In a nutshell, they are insurance contracts that make regular payments to you either immediately or at some point in the future. You can purchase an annuity to help grow or protect your retirement savings or to provide you with guaranteed income.
Different types of annuity
There are various kinds of annuity available, which provide different levels of income for you and potentially for your dependants. The level of income offered by a specific sort of annuity will depend on the supplier that you use and the options that you select. In case you’re uncertain whether a particular annuity may be suitable, you may want to seek further advice. A regulated financial adviser may be able to help if you need someone to recommend a definitive strategy.
The different types of annuity that are available today include:
A lifetime annuity provides an income stream for the rest of your life (as the annuitant) or the rest of the lives of the annuitants for a joint life last survivor annuity. These are the most common type of pension annuity (also known as compulsory purchase annuities or just as annuities). As a rule of thumb, the older you are when you take out an annuity, the higher the income (annuity rate) you’ll get.
There are two types of lifetime annuity to choose from:
- Basic lifetime annuities – where you set your income in advance
- Investment-linked annuities – where your income rises and falls in line with investment performance, but will never fall below a guaranteed minimum
Enhanced annuities work on the assumption that your life expectancy is reduced if you have certain medical or lifestyle conditions. Annuity providers see you as someone that they’ll have to pay for less time than someone in a better state of health. Therefore they compensate you by paying you a higher income, essentially using up your pension pot more quickly. This higher income is paid for life, even if your health improves or you change your way of life.
Impaired life annuities
These are a type of lifetime annuity offered by some insurance companies/annuity suppliers that are intended for people that suffer from, or have suffered from, a medical condition that results in a reduced life expectancy. To meet all requirements for an impaired life annuity, you will need to complete a medical history questionnaire. The annuity rate offered is based on an estimate of your personal life expectancy calculated using the medical information supplied.The annuity provider may also ask for further information from your doctor and/ or ask you to attend a medical examination.
These are offered by some insurance companies/annuity suppliers where they base the annuity rate they offer on where you live. The assumption based on this being that individuals living in different parts of the country have different life expectancies – broadly speaking, if you live in a wealthier area, you’re likely to live longer than someone living in a less affluent part of the country. If you’re likely to live for longer, the annuity will be paid for longer so you’re more likely to be offered a lower annuity rate.
These are a type of annuity that only pay income for a fixed term or until you die, if earlier. Temporary (or fixed-term) annuities tend to offer a higher annuity rate than lifetime annuities because they’re paid for less time. This means you won’t necessarily have to use your entire pension pot to buy a retirement income.The maximum term for a temporary annuity is 5 years.
As the name suggests, the income received from investment-linked annuities will vary in line with the value/performance of an underlying investment.If the investments perform well your annuity income could grow considerably. Likewise, if they don’t you could see a significant decrease. This is why most investment-linked annuities offer protection with a minimum income limit. This is a limit on how low your income can fall.
Purchased life annuities (PLAs)
A purchased life annuity (PLA) is an annuity purchased from an insurer. Its terms must include a life contingency. Usually the annuity will be for life, but it could be for a term ascertainable by reference to life. It provides a guaranteed income for life, in exchange for a lump sum.
Each annuity payment comprises a return of part of the capital plus a sum reflecting, in economic terms, interest. The amount of this return depends on your age when you originally purchased the PLA.