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Pension Annuities

The Different Types of Pension Annuities & How They Work

Pension annuities as retirement income

Pension annuities are a common way in which older people can guarantee themselves a long-term retirement income. A pension annuity is an insurance product that an individual can buy from an insurance company. The buyer pays a lump sum, and then receives guaranteed regular payments from the insurance company for the rest of their life. If you want to read a more general overview of annuities, you can read Age Space’s Guide to Annuities.

There are a large variety of pension annuity products that your parents may be interested in, and it can be difficult to make sense of which one might be most applicable to their circumstances and needs. This guide will help you to understand all of the retirement annuity options that your relative may be considering, including single-life annuities, joint life annuities and deferred annuities. You will also find more information about the different ways in which pension annuity rates can be calculated, and the types of guarantees that there are to choose from.

Warning: Consider Other Options

There is no guarantee that your relative will receive back all of the money that they invest in their pension annuity, let alone receive back more than they invested. If your relative dies soon after purchasing a pension annuity, the money that they have invested is lost

It may be better to consider other retirement finance options that carry less risk, such as downsizing.

The Different Types of Pension Annuity

A pension annuity is an annuity product that provides an individual or a couple with a secure retirement for, in most cases, the rest of their lives. Your relative pays a lump sum from their savings to an insurance provider in exchange for guaranteed payments made back to them every year.

There are different types of annuities for retirement, which differ in terms of when they begin, guarantees, and what happens after an individual dies. Below you can find out more about the various types of pension annuity.

Lifetime Pension Annuities

Single Life Pension Annuity

A single life pension annuity is the most common type of pension annuity. With a single life pension annuity, an individual will pay a lump sum to an insurance company, and receive regular payments for the rest of their life at an agreed sum. The payments are made until the buyer dies, at which point payments cease.

Joint Life Pension Annuity

Joint life pension annuity

Like a single life annuity, a joint-life pension annuity provides an individual with a regular income for the duration of the buyer’s life, but the annuity payments can be transferred to a nominated beneficiary after the buyer’s death.

The payments will continue to be paid to this beneficiary (normally a spouse or partner) until their death. Annuity providers will require that this individual is named when the pension annuity is purchased because they will take the future beneficiary’s age and health into account when determining the annuity rate. A joint life pension annuity will generally have a lower annuity rate than a single life annuity.

Enhanced or Impaired Life Pension Annuity

An enhanced pension annuity is an annuity for retirement package available to people who meet certain criteria that decrease an individual’s life expectancy, such as having high cholesterol, high blood pressure, or being a regular smoker. Enhanced annuities offer higher annuity rates, and therefore larger payments, because the annuity provider is assuming that they will have to make fewer payments overall.

Deferred Pension Annuity

A deferred pension annuity allows the buyer to decide against receiving any annuity payments for an agreed period of time (often around 5 or 10 years) after they purchase the pension annuity. The annuity provider then invests the buyer’s money, looking to grow it by the time the buyer wants to start receiving payments.

At the end of the deferral period, the annuity provider then pays the buyer interest on the money that they invested, as well as profits from the investments. At this point, an individual can choose to receive annuity payments from the now-larger pot of money, meaning that they would receive more per month compared to an annuity that has started paying out immediately.

Fixed-Term Pension Annuities

Temporary Annuity

A temporary pension annuity is a type of fixed-term pension annuity that only pays income for a fixed period of time (e.g. 5 years),  or earlier if the buyer dies in this period. Temporary annuities usually offer a higher annuity rate than lifetime annuities because they are paid for a shorter period of time. There is also the advantage for the buyer of being able to buy a pension annuity with potentially a better annuity rate later down the line, when the buyer is older.

Guaranteed-Term Annuity

A guaranteed-term pension annuity ensures the buyer’s payments will not cease even if they die soon after purchasing the annuity. If they do die within the period of the annuity, then the money will be redirected to their estate or a partner/spouse until the end of the agreed annuity length. For example, if an individual dies 6 years into their 10 year guaranteed-term annuity, the money will be paid to their estate nominated beneficiary for years 7 to 10. Guaranteed-term annuities usually provide lower annuity rates than those that do not have a guaranteed-term.

Immediate Needs Annuities

Immediate needs annuities, also known as immediate care annuities, differ from pension annuities in that the annuity money is paid directly for care costs. Instead of the money being directed to the buyer, immediate needs annuities can be paid directly to the care provider, tax-free. This can be helpful in capping the high cost of care plans.

You must be medically assessed as needing immediate care, as well as needing long-term care, to be able to purchase an immediate needs annuity. You can read more about immediate needs annuities in our guide to Immediate Needs Annuities.

Annuity Rates and Your Retirement Income

An annuity rate refers to the amount of money that an individual receives each year, relative to the amount of money that they paid for the annuity product in the first place.

Annuity rates are usually presented in terms of how much money an individual would receive each year for every £100,000 paid in. For example, a 5% pension annuity rate would mean £5,000 a year for every £100,000 paid in. With a 5% pension annuity rate, this means that an individual would have to live for an additional 20 years from the point of purchase in order to have made back all the money that they paid for their retirement annuity.

How are Annuity Rates Calculated?

How annuity rates are calculated

Annuity rates are calculated on an individual-by-individual basis. There are a number of factors that will determine the annuity rate that your relative will be offered, including their health status, age, and where they live. This is because all of these factors help the insurance providers to estimate how much longer they are likely to live.

People expected to live for longer tend to be offered lower annuity rates. People expected to live for a shorter period of time are usually offered higher annuity rates – because they insurance company expects to make fewer payments. 

The amount of money that your relative is able to invest in the annuity product is the main factor which determines the sum of money that they will receive each year. The greater the size of the investment, the more money your relative will receive each year, whatever the annuity rate is. Before making the annuity purchase, up to 25% of an individual’s pension savings is able to be withdrawn as a tax-free cash lump sum.

Pension Money Available Immediately

When taking out an annuity for retirement with money from an individual’s pension pot, they are also entitled to take out a cash-free lump sum. This money can be helpful in the case of needing to make any large purchases between annuity payments, or to cover unexpected costs.

Top Pension Annuity Providers

We have put together a guide to the biggest providers of pension annuities in the UK , where you can read more about the types of pension annuity that each insurance company offers. Many annuity providers also have online pension annuity calculators so you can estimate how much your relative may be eligible for.

Pension Annuity Rates Explained

There are different types of pension annuity rate that exist. Below you can read more about the different annuity rate options that exist.

Fixed Annuity Rates

A fixed annuity rate is one that will not change for the duration of the buyer’s lifetime. This means that the buyer will receive exactly the same amount of money every year from their annuity payments.

Annuity rates explained

For example, a woman aged 60, in good health, non-smoking, living in an AL9 postcode, may be offered a fixed rate 4% pension annuity rate. This means that she will receive £4,000 per year (before tax) every year for the rest of her life. She will have to live for an additional 25 years in order to receive back all of the money that she invested. If she lives for fewer than 25 years, she will have lost money on her investment, but if she lives for longer than 25 years then she will have made money from the annuity.

Increasing Annuity Rates

An increasing annuity rate is not fixed – the annuity rate increases slightly each year, meaning that the sum of money received each year also increases. With an increasing annuity rate, the starting payments will provide much less than the starting payments would be with a fixed-rate annuity, but over the course of a lifetime they can end up providing more. The year-on-year increase tends to be about a 3% to 5% increase in the pension annuity rate each year.

For example, an individual may be offered a 2% annuity rate in their first year, but this could be expected to rise to around a 4% annuity rate after 15 years, if the rate is increasing by 5% each year. This can be useful if you think it is likely that your relative will need more money in the distant future than they do in the near future.

Index-tied annuity rates

With an index-tied (or inflation-tied) annuity rate, the pension annuity rate will rise and fall with current levels of inflation, and the cost of living. This means that the annuity rate increases when the cost of living increases, but it also means that the annuity rate will fall if the cost of living decreases.

Other Costs

When purchasing annuities for retirement it is important to consider the cost for the services of a financial advisor. Some insurance companies also have a fee to pay for administration costs involved in the pension annuity purchase. This could include the costs for printing and posting.