An annuity converts your pension fund into retirement income. Shop around for the best deal as, once purchased, you can't change your annuity provider.

When you approach retirement age, you will have to decide what to do with the pension fund you’ve built up. The most common option is to buy a lifetime annuity (commonly referred to as just an annuity).

This converts your savings into an annual pension, giving you a guaranteed income payable for life, or for a specified period of time.

Your pension income will depend on several different factors, including:

  • the amount of money in your pension fund
  • the annuity rate
  • the type of annuity
  • and your age, health and lifestyle

Annuities have had some bad press, as fees can be high, but they’re still the best option for the majority of people. It’s vital that you shop around for the best value annuity though, as once you’ve bought your annuity, you can’t change it.

Buy according to your needs

Different types of annuity suit different people’s needs and circumstances. If you’re in a couple, think about whether you want a single life annuity just for you, or a joint life one that will pay out to your spouse or partner after your death (usually at a lower rate).

You can also choose between a level annuity, escalating annuity, or inflation-linked annuity.

  • A level annuity pays you the same income every year. They have a higher starting income than escalating annuities, but leave you vulnerable to inflation. Even low levels of inflation can significantly reduce your standard of living.
  • An escalating annuity rises each year at a fixed rate. It may start off lower than a level annuity, but will increase at a fixed rate (e.g. 3%) each year.
  • An inflation-linked annuity rises each year in line with the retail price index. This means that your annuity will be protected against inflation, but will start off at a much lower rate.

Start by checking what your pension provider is offering you, as they may offer a higher payment rate than those available elsewhere. But you don't have to buy from your pension provider and can shop around for the best annuity deal. This is known as the open market option.

Contact the Pensions Advisory Service for free information and guidance about this.

Age UK also offers an annuity service, provided by Premier Retirement Services, that can help you shop around for a better rate. Call 0845 600 9269 for a quote.

Small pension pots

If you’ve had several jobs during your working life, you may have multiple ‘small pots’ of pension funds and be wondering what to do with them.

As of April 2012, you can cash in up to two pension pots of less than £2000 and take the money, rather than being forced to purchase an annuity with them. This is known as trivial commutation.

Jargon buster

  • Impaired life annuity: these pay out a higher income if you have health problems that may shorten your lifespan
  • Enhanced annuity: you may be eligible for one if you’re overweight, smoke, have worked in certain occupations or live in certain areas of the country.
  • Guarantee period: you can guarantee your annuity so it pays out for a specific number of years. If you die before then, the income will be paid to your partner or another dependant.
  • Short-term annuity: you can use part of your pension pot to buy an annuity that provides a short-term income. The rest of your pot is left invested, and you can choose to buy a lifetime annuity when your short-term one expires. You might choose a short-term annuity if you don’t want to commit your pension fund to a life annuity as you believe rates might get better in the future.

Find out more about annuities, including the different types available, on the Money Advice Service website.

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