Annuities are a common way for older people to improve their financial security, including funding long-term care costs, particularly if they are worried that their savings may run out.
In this guide you will be able to learn more about how annuities work and the different types of annuity that your relatives may be interested in. This includes information about who is eligible, the risks associated with annuities, and how annuity rates are calculated.
What Is An Annuity?
Annuities are insurance products that can provide an individual with a long-term regular retirement income, or guaranteed funding for long-term care costs, in exchange for a lump sum from that individual’s pension savings. The two most common types of annuities are pension annuities and immediate care needs annuities, which you can read more about below.
Warning: Consider other financial options
Buying an annuity is a risk, and it is possible that your relative will receive back less money than they used to purchase the annuity. It is worth considering all of the other financial options for generating retirement income, such as releasing funds through the sale of the house and for example, downsizing.
The Different Types Of Annuity
Immediate Needs Annuities
Immediate care needs annuities exist for people who need help paying for care fees. Immediate needs annuities are different to pension annuities in that the annuity provider pays the money directly to your relative’s care provider. This may be a care home or provider of in-home care. Immediate care needs annuities can provide security that your relative’s care costs will not become unaffordable should they increase. An individual must be medically assessed as needing immediate care, as well as needing long-term care, to be able to purchase an immediate needs annuity.
NHS Continuing Care funding
If you are looking for alternative types of financial support for expensive care costs, you may want to read about NHS Continuing Care funding. This is package of healthcare paid for entirely by the NHS for people with complex and severe health needs.
The most common type of annuity is a pension annuity. With a pension annuity, your relative pays a lump sum from their pension savings to an insurance company in exchange for guaranteed regular payments for the rest of their lifetime directly into their bank account.
There are a number of different types of pension annuities that exist. Pension annuity products can vary by their length, the timing of payments, guarantees, and what happens to the annuity after the buyer’s death.
The Main Annuity Providers In The UK
Researching the market for annuity packages and rates offered by different providers should be carried out before making a decision, as they can vary a lot. Different providers also have different minimum and maximum ages for purchasing an annuity. Another factor to consider is whether or not you already have any of your money kept with a provider, as this may simplify the annuity process.
We have listed below some of the UK’s best-known annuity providers.
Aviva offer annuities for people aged between 55 and 90 years old, and they are members of the Financial Services Compensation Scheme. They have a pension annuity calculator on their website to help you estimate how much your relative is likely to receive per month.
Just provides a range of individually-underwritten annuity options. You cannot buy their annuity services directly through their website, but can read more about their services and how to purchase them from their website. Just offer guarantee periods of up to 30 years.
Legal and General
Legal and General offer a range of annuity packages, including enhanced annuities, joint-life annuities, and deferred annuities. Legal and General also offer a pension annuity calculator service on their website, to help your parents to estimate their monthly income from a Legal and General pension annuity.
Scottish Widows offer annuities for people aged between 55 and 75, and who have a pension fund of £10,000 or greater after they have withdrawn any cash. Annuity payments from Scottish Widows can be made monthly, quarterly, half yearly or annually, in advance or in arrear.
How Annuity Rates Work
The amount of money that an individual receives each year from their annuity, relative to how much money they have invested, is referred to as the annuity rate. Annuity rates tend to be presented in terms of how much money someone would receive per year for every £100,000 invested. For example, a 4% annuity rate means an individual receives £4,000 a year for every £100,000 paid in. With a 4% annuity rate, your relative would have to live for 25 years from the time of purchase in order to make back their original investment.
The factor that most affects how much money your relative will receive per year is how much money they invest in the annuity. The more money that is invested, the more money they will receive back each year. It is worth knowing that up to 25% of an individual’s pension savings can be withdrawn as a tax-free cash lump sum.
Annuity rates are worked out on an individual basis. This is because your relative’s age, postcode and health status will also affect the annuity rate that they will be offered by the insurance company. Younger and healthier individuals are usually offered lower annuity rates. Similarly, the higher the life expectancy of the area that an individual lives in, the lower the annuity rate is likely to be.
There are different types of annuity rates available, such as fixed-rate annuities, increasing annuities, and index-tied annuities. You can read about the different types of annuity rates in our guide to how annuity rates work.
Other Annuity Costs & Charges
There are other costs to consider when buying an annuity. The provider may charge for administration costs, such as accounting and postage. There is also the cost to be paid for the services of a financial advisor. In most cases a financial advisor will demand a fixed fee for their services, but in some cases they may request a percentage of the annuity purchase price.
Important Considerations about Annuities
Annuities have potential advantages but also risks, and it can be hard to know if they will be right for your parents. Though they can provide peace of mind that your parents will never run out of money completely, there is also the risk that they will pay more for the annuity than they end up receiving.
If you are unsure about the best option for your parent’s financial circumstances, take proper advice and speak to a financial advisor. They can also outline finance alternatives to annuities that you may want to consider, such as equity release.
If you think a pension annuity might be a good option for your parents, it is important to choose an annuity product that meets their specific needs.
Risks of Annuities
- Once the ‘cooling-off’ 30-day period has expired, your relative cannot change their mind about their annuity, even if personal circumstances change or inflation (the cost of living) rises steeply.
- If your relative dies relatively soon after taking out the annuity, the money used to fund its purchase cannot be returned – even if they have only received a fraction back from the annuity provider as income payments. It is possible to protect against this happening with a Guaranteed Term annuity but it will mean having a reduced annuity rate.
- The income your relative will receive is dependent upon annuity rates at the time of purchase. Even if annuity rates increase later, your relative is stuck with their rate.
- If your relative has a fixed annuity rate, and the cost of living increases, your relative’s annuity payments will not increase with the cost of living.
- Most ‘advantages’ or ‘guarantees’ on an annuity product reduce the annuity rate your relative will be offered.
Frequently Asked Questions about Annuities
In most cases, the annuity stops being paid after somebody dies, even if they have not received back all of the money they invested in the first place. With some annuity options, such as a guaranteed term annuity or joint-life annuity, the payments can continue to be paid to a nominated beneficiary such as a spouse or partner, but this type of annuity will have a lower annuity rate.
Yes. Annuity income is technically ‘earned income’, and therefore is taxed. The only exception to this is care needs annuities. With care needs annuities, the money paid directly to the care provider from the insurance company is tax-free.
There is no definitive minimum age for an annuity, but most providers will not offer annuities for people aged under 55. Some providers have a minimum annuity age of 60.
It usually takes around 30 days to set up an annuity, including the paperwork and the transfer of funds.
You can only change your mind after buying an annuity within the first 30 days – known as the ‘cooling-off period’. After this point you cannot change your mind about the annuity, or transfer the annuity to another provider.
If you have access to your pension funds then you can buy an annuity before you retire, but financial advisors tend to advise against doing this. This is because the younger you are when you buy an annuity, the less money you can expect, and most providers will not let you buy one if you are younger than 55.
Getting Independent Advice on Annuities
It is advisable to pay for the services of a financial advisor if you are considering purchasing an annuity. A financial advisor can offer personalised advice about annuities for you or your relative’s unique financial circumstances. They would also be able to identify which types of annuity would be most appropriate for an individual, and the specific risks that need to be considered.