An annuity is a pension product that converts your retirement pot into a steady stream of guaranteed income. For many people, an annuity forms the backbone of their long-term retirement plans, but it may not suit every retiree.
What is an annuity?
An annuity is an insurance product that offers a guaranteed income in retirement. You can buy one with your defined contribution (DC) pension pot, such as a workplace scheme or a personal pension, either to cover the remainder of your life or for a set number of years.
Commonly, people opt to take 25% of their pension as tax-free cash, with some opting to use the remainder to purchase an annuity, typically from an insurer. How much they’ll offer to give you every month depends on a number of factors, including the size of your pension pot, any health problems and your age.
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Annuities used to be mandated for most people with a DC pension, but the introduction of pension freedoms in 2015 meant retirees had more options, including using pension drawdown. But annuities still fill an important need within the retirement market, with a range of options available to cater to your needs.
Types of annuity
There are four main types of annuity. Various insurers and advisers may have slightly different names for each, so make sure that you inspect the details carefully when you're considering a purchase.
- Lifetime annuity: provides you with a set income for the remainder of your life
- Fixed-term annuity: provides you with fixed income for a set period, usually around 5-10 years
- Investment-linked annuity: provides you with some guaranteed income, but the rest is linked to investments – introducing a level of risk to your income in retirement
- Enhanced annuity: provides you with a higher income, based on your life expectancy (as estimated by the annuity insurance provider)
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